Wednesday, April 23, 2008

How I Could Have Made Almost $30,000 In One Day And Why I Didn't Do It

Last week's rally by Google showed how option buyers could make a lot of money on big move by a stock. On Friday, April 18, 2008, Google rose nearly 90 points on the strength of the earnings results provided on Thursday after the market close. For those who owned Google, this was great since the stock was down 35% year to date. However, one could have made significantly more by owning Google options that expired on April 18, 2008.

On Thursday April 17, 2008, Google closed at 449.54 the April 510 calls closed at $0.60. One day later, Google closed at 539.41 and the same options last traded at $29.90, for a net gain of 4883%. In other words, $600 used to purchase 10 calls on April 17 would have been worth about $29,900 on April 18, excluding commissions.

Knowing what I know now, paying $600 to make almost $29,900 appears to have been a "reasonable investment." While I briefly thought about buying a few out of the money call options, here's why I didn't do it:

  • The investment required a significant gain in only one day. It clearly depended on whether Google had great results and it required at least a 60 point gain in order to be in the money. These were two big "ifs." Even for Google, 60 points was a very big gain. 90 points was the largest advance ever by Google. For perspective, I thought Google might advance 20-30 points on good results.

  • Typically, out of the money options with one day to expiration become worthless. The 510s were far out of the money, by over 50 points. Buying such a option would be a long shot gamble, with a high probability of loss. On Thursday, I didn't think there was much chance Google would reach 500 on Friday.

  • My track record of predicting daily fluctuations is not that good. If it was, I'd be day trading and I'm not. While I was hoping Google would meet expectations, I thought there was a reasonable chance of miss. Over the long term, I would likely have more misses than big returns like Google.

  • To demonstrate my ability, or rather inability, to predict daily stock price, I'll do an evaluation of options for Apple and Amazon, which both report after the close today. Since I expect Amazon to beat estimates and Apple to meet expectations, I would consider the Amazon May 90 call for $2.04 and the Apple May 195 call for $1.90. At 11:00 AM today, Amazon and Apple are at $80.70 and $163.20, respectively. With this information, I will hypothetically buy one Amazon May 90 call. I will not buy the Apple May 195 call since the stock has not made a 32 point move during a month in the past.

    I'll report back after the close on how well my hypothetical position performs.

    Disclosure: I own shares of Amazon and Apple. I do not own any options for these stocks.

    4:40 PM Update : Amazon closed at $81.00 and the May 90 call closed at $2.24. However, after Amazon announced earnings that beat expectations, the stock began to drop, reaching $77.49 at 4:40 PM. Apple closed at $162.89 and the May 195 call closed at $1.45. Apple's earnings also beat the street estimates, but the stock dropped after hours, to $161.50 at 4:40 PM. It's good that I didn't buy either of the call options :-)

    For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

    This is not financial of investment advice. Please consult a professional advisor.

    Copyright © 2008 Achievement Catalyst, LLC

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