Ask the Trader: How Might My Long Call Option Perform? Using the Theoretical Price Tool

Suppose you buy a call option at a given strike price. Now what? The Theoretical Price tool on thinkorswim can help you assess what it could mean for your trade if the underlying stock reaches your price target by a certain date, if it goes the other way, if implied volatility changes, and more. bridge: Discovering options theoretical price
8 min read
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Key Takeaways

  • Understand the different factors that make call options prices move

  • Learn how the theoretical price tool can help project options prices 

  • Estimate your options premium at a given price and on a given date to help decide if the potential return on a trade is worth the risk

Suppose you’re eyeing a stock that appears to be an attractive buy for an intermediate-term trade. You’ve got a price target in mind, and you think that target may be reached within a matter of weeks. But rather than buy the stock outright, you’re thinking about buying a longer-dated call option.

You know that options prices (premiums) and their underlying stock prices don’t move in lockstep. Sometimes options premiums move incrementally, or bit by bit, while other times, they take off exponentially. And options premiums tend to decay, all else being equal, as the clock ticks toward expiration.

So here’s what’s puzzling you: If you buy a call option at a given strike price, how much might it be worth if the underlying stock reaches your price target at a specific point in time?

Finding that answer isn’t easy, because options premiums have a lot of moving parts. But if you’re going to place a trade, you’ll want to have some idea of how much your premium might appreciate given certain parameters.

So how might you go about setting your targets and expectations? Fortunately, the thinkorswim® platform can help you determine the theoretical price of an option.

The theoretical options price is based on the current implied volatility, the strike price of the option, and how much time is left until expiration. As prices fluctuate, values can change, including the theoretical value.

Let’s take a look at how the theoretical price calculator works. But before jumping in, here are a few important principles to remember:

  • The strike price you choose—whether it’s in the money (ITM), out of the money (OTM), or at the money (ATM)—can make the biggest difference to how your premiums move along with the stock price. 
  •  It helps to have a basic understanding of how options prices move relative to changes in the underlying stock (delta), the passage of time (theta), and changes in implied volatility (vega). You may have heard these lumped together as “the greeks.” If you’re new to options, consider brushing up on options greeks before you make that first trade.
  • You can forecast the future price expectations of a call option under different scenarios using the Theo Price (short for “theoretical price”) tool on the thinkorswim platform.

A Note on Strike Selection

Strike selection can be a blend of art and science—or more accurately, a blend of art and math. Strikes are either ATM, ITM, or OTM. The deeper ITM an option goes, the bigger the delta gets, which means the faster it changes price in dollar terms. But in percentage terms, these options move slower the deeper ITM they are.

Let’s say you bought a call and decided to close the trade for a profit if it hits your target or for a loss if the option loses 50%. If your call is ITM, then the stock will have to drop further before you hit the exit compared to a call that’s OTM.

OTM options, on the other hand, move faster in percentage terms. So although OTM options can lose faster compared to ITM options when stocks move the wrong way, OTM options provide the opportunity for large returns if the stock makes the move you’re looking for.

And if you’re trying to keep your initial outlay to a minimum, of course the more OTM your strike, the less you’ll pay up front. Remember, with a long option, your max loss is the premium paid, plus transaction costs.

Using the Theo Price Tool to Figure Out Premium Expectations

Here’s a quick overview of how to use the Theo Price tool on the thinkorswim platform. You can also watch a webcast (posted at the end of this article) on using the theoretical options price to help you analyze scenarios. (It’s among the many archived and live webcasts the TD Ameritrade team hosts each business day.)

Suppose that on July 1 XYZ is trading at $126.73 (see figure 1). You anticipate the stock is going to break above resistance, which is around $140, and potentially reach $145 by the end of the month.

Price chart with possible resistance level

FIGURE 1: THE BIG PICTURE. Looking at the chart, you think the stock could rise to around the $140 level. It may even break above resistance. How might you position a trade? Chart source: the thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.   

Let’s say you decide to buy a November 2020 call (that’s 142 days until expiration) in order to give stock XYZ plenty of time to reach that target price of 145. You decide the resistance level of $140 would make for a suitable strike price.

On the Analyze tab, take a look at the Option Chain for the November 2020 options (see figure 2). A 140 call costs roughly $10.05 per contract (or $1,005—remember that standard options control 100 shares of stock).

Option chain for calls

FIGURE 2: OPTION CHAIN. The November 140 calls will cost you $10.05, or $1,005 per contract. What might the price be before your options expire? Chart source: the thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.   

There’s a chance the underlying stock could reach $145 by July 30. If that happens, what will your position’s theoretical value be at that time? Although you can’t know what might happen between now and July 30, Theo Price gives you a “guesstimate,” all else remaining equal.

To find out, add Theo Price to your layout in the Option Chain and select it. This brings up the Theo price parameters window (see figure 3). Change the date to July 30 from the calendar (or by using the + and – buttons). Then adjust the underlying price using the + and – in the Stock price adj field. As you adjust the stock price, the Resulting price will change. You can keep adjusting until the Resulting price is in line with your preferred price target (in this case, $145). You could also tweak the Vol adj field to see how changes in implied volatility can impact the theoretical options price.

Theoretical price display in option chain

FIGURE 3: FIGURING OUT HOW MUCH YOUR OPTIONS COULD BE WORTH. When you display Theo Price on the Option Chain, you can fast-forward to a date in the future and adjust the Theoretical price parameters to set the Resulting price to your preferred price target. Chart source: the thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.   

Next, check the Theo Price column in the Option Chain (see figure 4). Notice that the theoretical price for a 140 call is projected to be $16.77 on July 30 if the underlying stock’s price reaches $145. That’s $16.77 in premium versus $10.05, so a projected appreciation of $6.72 (or $672). Is the potential return worth the risk? As always, that depends on your objectives and risk tolerance.

Theoretical price parameters for options

FIGURE 4: THEORETICAL PRICE FOR A FUTURE DATE. Adjust the date and price to figure out Theoretical price parameters for your options. Chart source: the thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.

Scratching the Surface

Coming up with options price projections used to be the domain of math-savvy traders. But with the Theo Price tool, it can be simple and quick. Just remember, these are “theoretical” projections, and the accuracy may vary.

Plus, in terms of informing your trading decisions, we’re just scratching the surface. You can try out other strikes and expiration dates.

Remember those greeks? Theta (time decay) is typically higher the closer your strike is to ATM. It also accelerates as you approach expiration. Theoretical price takes theta into consideration, but it leaves implied volatility (vol) constant. If you want to change vol in your analysis, you can tweak the Vol adj box.

And while you’re performing your scenario analysis, remember to check the downside as well. You could be wrong about your view on XYZ. Do you have a pain point if the trade goes against you? Is it a particular dollar amount in XYZ, or is it based on the premium you paid? Either way, Theo Price can help you assess the “bad half” of your exit strategy. 

Theo Price is a handy tool that can help you estimate potential risk and return. In other words, you don’t have to trade options half-blind, not knowing where an options position’s value may be headed over time and through different price levels. 


Key Takeaways

  • Understand the different factors that make call options prices move

  • Learn how the theoretical price tool can help project options prices 

  • Estimate your options premium at a given price and on a given date to help decide if the potential return on a trade is worth the risk
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