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Tip: Knowing when to take a profit is only a part of the option trader’s goal. It is equally important to know when to take a loss.
Example: Keeping Promises: You are the type of investor who believes in setting goals for yourself. So when you bought a call at 4, you promised yourself you would sell if the premium value fell to 2 or rose to 7. This standard reduces losses in the event that the option declines in value, while also providing a point at which the profit will be taken. You recognize that when it comes to options, time is the enemy and an opportunity might not return. Option buyers often do not get a second chance.
Goal-setting is important because realized profits can occur only when you actually close the position. For buyers, that means executing a closing sale transaction. You need to set a standard and then stick to it. Otherwise, you can only watch the potential for realized profits come and go. Your paper profits (also known as unrealized profits) may easily end up as losses.
If you buy a call and the stock experiences an unexpected jump in market value, it is possible that the time value will increase as well, but this will be temporary; to realize the profit, it has to be taken when it exists. The wider the out-of-the-money range, the lower your chances for realizing a profit. The leverage value of options takes place when the option is in the money. Then the intrinsic value will change point-for-point with the stock.
If the stock’s market value is five points or more above striking price (for calls) or below striking price (for puts), it is said to be deep in the money.
These definitions are important to call buyers. A deep out of the money option, because it requires significant price movement just to get to a breakeven point, is a long shot; and a deep in the money call is going to demand at least five points of premium just for intrinsic value, in addition to its time value. So the majority of call buyers will buy within the five-point range on either side of the striking price. This provides the maximum opportunity for profit with the least requirement for price increase to offset time value.