We’ve been noodling around in the QQQs in recent weeks for two reasons. The first is to make money at it; the second, to gain a better feel for the way the puts and calls behave in this very heavily traded vehicle. Our approach usually begins by plugging in some numbers on the Options Calculator, based on the underlying vehicle trading at a targeted swing point. Typically, we try to buy out-of-the-money puts at projected rally peaks, and calls at swing lows. The calculator pictured below is what I use and recommend, a $99 item from The Option Strategist, Larry McMillan. It shows how much the Feb 42 calls should sell for if the QQQs are trading at 42.14. The figure it gives is 0.70, which is exactly where they closed.

(Click on image to enlarge)

Actually, 0.70 was where they were going to close, until some wise guy paid a nickel more for them just as the final bell sounded. Why was he so eager to pay up? Well, a likely reason is that the guy owns a bunch of them and they will be marked-to-market overnight. Let me explain by way of an example. If you were going to hold a thousand Feb 42 calls overnight, would you rather they be valued at 0.70, or at 0.75? The answer is obvious. Having them valued at the higher number is the same as having an  additional $5,000 in your account. And if you hold other securities on margin and are paying interest on them, the extra $5,000 will help reduce this expense. That is one reason why floor traders jockey the marks around in the final moments of the day.

Outsmarting the Computer

The foregoing is intended to show that options prices sometimes fluctuate for reasons that have little or nothing to do with theoretical valuations. A Black-Scholes model is of course a good place to start if you wish to determine how much an option “should” sell for. But when the opening bell rings, it is the give-and-take of various forces in conflict that will determine an option’s value from one second to the next. This implies that, on a given day, if you watch an option closely enough, you will come to understand it intuitively far better than a computer could. In fact, if you dog-tail an option for a couple of days, you’ll be able to dispense with the calculator and trade ‘em up by the seat of your pants.

Yesterday, we tried to do just that when the Feb 42 calls were getting hammered in the first hour. As the QQQs fell toward a predicted hidden-pivot swing point at 41.69, we were 0.50 bid for some Feb 42 calls. They traded at that price, as some of you will already be aware, but we got none. Consider it useful intelligence; for, when you get shut out in exactly that way, you’re going to feel more confident paying 0.55 for the options when the QQQs rise just slightly --  which they did.

It should not be lost on those who worked this trade that, in the space of a single day, the Feb 42s gained 50% in value. This is yet one more reason why I rarely advise trading options that cost more than a buck. Nickel-and-dime trades are where one stands the best chance of leveraging one’s bucks with relatively little risk.