Option Basics --- Intrinsic Value and Time Value

The Components of Option Price

When we buy an option, we pay a price for the contract. This price is called “premium”.

This option price is consists of 2 price components, the intrinsic value and the time value.

The intrinsic value of an option is the difference between the actual price of the underlying security and the strike price of the option.

The time value is simply the difference between option value and intrinsic value. It is determined by the remaining lifespan of the option, the volatility and the cost of refinancing the underlying asset (interest rates) etc.

Time Value = Option Value - Intrinsic Value.

The time value will decrease with the time. Besides, the time value would also decrease when the underlying security price moves away from the strike price.

For better understanding of the option price, please see the following chart.

Chinese Stock Market and US Stock Market

I am sorry for missing an article for yesterday! There were two reasons: One was that I was busy on trading in Chinese stock market; other one was because I could not pick any US stock in the current situation.

Today (or last night in Eastern Time), 4/21/06, the Chinese stock market reached another yearly new high. It has gone up 22% since January 1, 2006. After a 4 years decline, the Chinese market is on its up track.

Last summer, after many years, I went back to China. I saw many things are very interesting. The most attractive thing is the Chinese stock market. Chinese stock market was very quite because it hurt most of its investors. From its last top in June, 2001, while the economy advancing stably, the Chinese stock market had lost more than 50% of its value. From my opinion, most of its stocks are under value. It was a great investment opportunity.

When I came back from China, I quickly set up a Chinese stock account and started trade Chinese stock through the internet. From early of September when I started my first trade, the Chinese market went down for less than 3 month, and then started its rally. From its lowest point till today, the Chinese stock market has gone up for more then 30%. As of today, I still think the most of the Chinese stocks are at bargain price!

Probably because the tradition or the ideology is different with western, the Chinese stock market behaves much differently. Even though both stock markets use the same terminologies, perhaps the different reading and understanding, the trading skill sets are far away from each other. To us, the peoples who know US market better, it is very challengeable. While, I paid a lot of tuition, or mistakes, for the difference, now it is the time to begin the harvest.

My dear readers, you should look into the Chinese stock market also. There are more chances then the US stock market.

I felt the difference strongly. Last night, both markets reached their new highs and both markets might face possible adjustments. In Chinese market, I could easily cash my gains from some advanced stocks, and transfer into some stocks that have more potentials. In US market, I could not.

If you review my recent stock picks, you should noticed that I shifted to “defensive” area already. I focused on metals, oil and even the penny stock. The main reason is not only the oil or gold price, but also because many other stocks (on my list) do not have big potential for introduce. In fact, I have started looking for stocks that I can bet it down since last week. Meanwhile, I don’t think now is the time to release them yet.

Last night, I didn’t have a good one for buying because it is too risky; and I didn’t have a good one for selling because it is too early. So, writing nothing probably was my better selection.

I feel bad for missing a homework and for readers who visit my blog daily. But by watching today’s market, I think my choice is right.

Trade Penny Stock --- NWACQ.PK

NWACQ.PK (Northwest Airlines Corp.)

Northwest Airlines Corporation, through its subsidiary, Northwest Airlines, Inc., engages in the commercial transportation of passengers and cargo. It operates domestic and international route networks and directly serves approximately 900 cities in 160 countries in six continents.
The company and certain of its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in September 2005.

It is a risky stock at this moment, but it has huge potential once it got out of bankruptcy.

Its next quarter’s earning estimate is good. And I have noticed its abnormal activity in the past few days. Its closing price of today is 0.58. I suggest you keep an eye on it.

My suggestion: Buy (7)

Invest in Oil --- COP

COP (ConocoPhillips)

ConocoPhillips operates as an integrated energy company worldwide.

4/26/06 is its Earnings announcement date. Its closing price of today is $70.64.

COP has very good fundamentals. It is good for short and long term investors.

My suggestion: Buy (8)
Instruction: It has strong correlation with oil price. When oil price reached the top and stable, you should reduce your holding; when the oil price dropped, you should increase your holding.

Get In the Hot Sector --- APA

APA (Apache Corp.)

APA engages in the exploration, development, and production of natural gas, crude oil, and natural gas liquids in North America and international. It has total estimated proved reserves of 976 millions of barrels of crude oil, condensate, and natural gas liquids; and 6.8 trillion cubic feet of natural gas.

Its closing price, as of 4/17/06, is $68.89.

APA has excellent fundamentals. It is good for both short and long term investors.

My suggestion: Buy (8.5)

Weekly Review (4/10/06 -- 4/13/06)

Earning, Earning…

The news, the bad ones, overcame the optimistic in this week. The market did not perform as we expected. This week, the Dow was up 0.16 percent and NASDAQ was down 0.55 percent.

The price of crude oil is nearly $70 now; the bound yields are above 5 percent; and the gold is above $600 per ounce. The inflation or Fed rate concern suddenly stand out and stirred the market. Besides that, there was no other shining point.

While, we better focus on the coming week. The next week is so important because some key companies will release their earning. Let’s take a look the earning calendar:

4/17: C
4/18: JNJ; MER; MOT; PBG; TXN; WM; WFC; YHOO
4/19: AAPL, ET, EBAY, HON, INTC, JPM, JNPR, KFT, NYX, PFE, KO
4/20: BAC, GM, GOOG, MRK, NOK, BK, NDAQ, UPS
4/21: F

In this list, we have Intel, Apple, Google, Yahoo, Motorola, Nokia, and eBay; we have Citigroup, JPMorgan Chase, Bank of America, Merrill Lynch, NYSE, NASDAQ and Bank of New York; we have Johnson & Johnson, Merck and Pfizer; we also have GE, Honeywell, UPS, Ford and Coca-Cola. Those companies’ earning result will drive next week’s market. Because of the better economy, most of them will give a better earning. The only question is: Can they on top of the expectation?

There are some events we need to know also:

4/18: The U.S. Producer Price Index and the minutes of the Federal Open Market Committee's March 27-28 meeting will be released
4/19: The U.S. Consumer Price Index will be released

We cannot guess what will be the outcome, but we can assume their total impact is neutral or little negative.

The fears of inflation and Iran will be there still. Most of the bad news have come. What else? How higher the oil price will be?

I reviewed and reviewed again. I think most of the earning results would be positive. Despite of the shadow of the bad news, the market of next week will still be lead by that good news and go up.

Instruction:
After the earning announcement, you should gradually reduce your positions. The option traders should catch this opportunity (Please referring to “Check the Earning and Bet on the Potential”).