Special Report for Gabbert Investment Group
Options Strategy: Understanding the Mechanics
Intrinsic Value, Time Value, Parity, Cost Basis, and Position Management
Intrinsic Value, Time Value, Parity, Cost Basis, and Position Management
Jim, this is a reference guide covering the options mechanics we discuss on our calls. Each section is expandable, click to open. At the bottom of each section you can type a question and get an instant answer. Take your time with it.
A call gives the buyer the right to buy 100 shares at the strike price. A put gives the buyer the right to sell 100 shares at the strike. The seller collects a premium and takes on the obligation.
You can be on either side. Buy a call = bullish bet. Sell a call = collect income, cap upside. Buy a put = protection. Sell a put = collect income, agree to buy stock if it drops. We are almost always on the seller side, collecting premium.
Intrinsic = real value right now. For a call: stock price minus strike. For a put: strike minus stock price. Can never be negative.
TMV (Time Value) = everything else. Decays every day. Reaches $0 at expiration. This is what works in our favor as sellers.
| Option | Price | Intrinsic | TMV |
|---|---|---|---|
| $380 Call (ITM) | $26 | $20 | $6 |
| $380 Put (OTM) | $6 | $0 | $6 |
| $400 Call (ATM) | $12 | $0 | $12 |
| $400 Put (ATM) | $12 | $0 | $12 |
| $420 Call (OTM) | $3.50 | $0 | $3.50 |
| $420 Put (ITM) | $23.50 | $20 | $3.50 |
Own 100 shares + sell a call. Collect premium, but your upside is capped at the strike.
| ADBE at Exp. | P&L |
|---|---|
| $270 | −$20 (stock −$30, keep $10) |
| $290 | $0 Break Even |
| $300+ | +$10 (max, capped) |
Sell a put + set aside cash. If stock drops below strike, you buy it. If not, keep the premium.
| ADBE at Exp. | P&L |
|---|---|
| $270 | −$20 (assigned, $30 loss, keep $10) |
| $290 | $0 Break Even |
| $300+ | +$10 (max, put expires) |
At the same strike and expiration, the TMV on the call and the put are always equal. Same income = same P&L.
| MSFT at Exp. | Covered Call | Cash Secured Put | |
|---|---|---|---|
| $370 | −$30 + $12 = −$18 | = | −$30 + $12 = −$18 |
| $388 | B/E | = | B/E |
| $400+ | +$12 (capped) | = | +$12 |
MSFT at $400. The $380 call costs $26 ($20 intrinsic + $6 TMV). The $380 put costs $6 (all TMV). Both collect $6 of real income.
| MSFT at Exp. | ITM $380 Call ($26) | OTM $380 Put ($6) | |
|---|---|---|---|
| $360 | −$40 + $26 = −$14 | = | −$20 + $6 = −$14 |
| $380+ | +$6 (capped) | = | +$6 |
Same concept, other direction. MSFT at $400. The $420 put costs $23.50 ($20 intrinsic + $3.50 TMV). The $420 call costs $3.50 (all TMV).
| MSFT at Exp. | Deep $420 Put ($23.50) | Far OTM $420 Call ($3.50) | |
|---|---|---|---|
| $380 | −$40 + $23.50 = −$16.50 | = | −$20 + $3.50 = −$16.50 |
| $420+ | +$23.50 | = | +$20 + $3.50 = +$23.50 |
ORCL at $138. Short the $145 put, expiring Friday, $7 in the money. Two paths:
Buy back $145 put: −$7.10
Sell new $145 put: +$10.00
Net new TMV: ~$2.90
Buy stock at $145
Sell $145 call: +$3.00
TMV collected: ~$2.90
ORCL at $148. Sell $145 put for $2. That $2 is in your account, but it is not profit yet.
| ORCL Goes To | Result |
|---|---|
| $150 (stays up) | +$2. Put expires. You keep it. |
| $140 (drops) | −$3. Assigned, $5 loss, kept $2. |
| $130 (drops hard) | −$13. Assigned, $15 loss, kept $2. |
The real ORCL trade sequence:
| # | Action | Cash | Running Total |
|---|---|---|---|
| 1 | Sell $145 put | +$1.00 | +$1.00 |
| 2 | Buy back (stock dropped) | −$5.20 | −$4.20 |
| 3 | Sell new $145 put (same strike, longer dated) | +$7.00 | +$2.80 |
| 4 | Buy back at $7.00 | −$7.00 | −$4.20 |
| 5 | Sell $135 put | +$3.50 | −$0.70 |
The $1.80 "credit" on the first roll did not erase the $4.20 loss. After all 5 trades: −$0.70 and still short the $135 put.
Continuing the ORCL example. Short $145 put at $7, stock at $138. You want to roll down to $135.
Pay $3.50 debit to lower strike by $10.
Assigned at $145. Sell $135 call for $6.50.
Called away: −$10 stock + $6.50 call = −$3.50
MSFT at $400. Sell $400 put for $5. Stock drops, you get assigned. Brokerage shows cost basis: $395.
Called away: stock loss −$5 + put premium $5 = $0 net.
The $5 you collected was for nothing.
Called away: stock $0 + put premium $5 + call premium = profit.
You keep the $5 AND collect call income.
Every dollar of TMV you buy back is income lost. Close early only when (a) the option is nearly worthless ($0.05 to $0.10 left) or (b) a new trade offers better daily TMV.
When the stock is below your cost basis, do not sell calls close to the current price. That caps your recovery. Either sell far OTM short dated calls for small income, or sell nothing and wait for the stock to come back. When you are in a hole, do not build a ceiling over it.
When the market rallies and VIX drops to the low end of its range (14 to 16 area), premiums shrink because volatility is low. This is the time to close winning short puts that have already decayed, lock in the profit, and wait for volatility to return before selling again. Higher VIX = higher premiums = better entries. Do not force trades in a low VIX environment just to stay busy.
When the stock is above your cost basis, sell short dated calls near the money and let the stock get called away. Getting called away at a profit is a win, not something to avoid. Do not sell long dated calls trying to squeeze out extra premium. Take the gain while it is there.
Instead of selling an at the money put, you can sell a put that is slightly in the money (a few dollars above the current stock price). You collect more total premium because there is some intrinsic built in. Your effective cost basis if assigned is lower. The trade off is a higher probability of assignment, but if you are comfortable owning the stock at that level, the extra premium is worth it.
| # | Rule |
|---|---|
| 1 | Option Price = Intrinsic + TMV. Know which is which. |
| 2 | Call TMV = Put TMV at the same strike. That is parity. |
| 3 | Covered call = Cash secured put. Same trade. |
| 4 | Big premium on a deep option is mostly intrinsic, not income. |
| 5 | Rolling a put = Assignment + Covered call. Same thing. |
| 6 | Buying back for a loss raises your cost basis. |
| 7 | Premium collected is not profit until the trade is closed. |
| 8 | Credit rolls can be losses. Track the running total. |
| 9 | Rolling down for a debit = locking in a loss. |
| 10 | Sell calls at the strike, not the "cost basis." |
| 11 | Stock down: wait for recovery, do not cap upside. |
| 12 | VIX low: take profits, wait for volatility to return. |
| 13 | Stock up: get called away. Take the win. |
Jim, if any section does not click or you want to walk through a specific trade, give me a call. Best, Brandon