From time to time when I make a recommendation to execute a buy-write, I get the question “Why not just buy the calls?”
Option action in ON Semiconductor (ONNN) yesterday and today is a perfect example of why, in certain circumstances (such as this one), buy-writes are the better tactical action.
ONNN popped up on my scanner yesterday when a trader bought 5,500 January 10 Calls for prices starting at $0.35 and up to $0.45 by the end of the day.
Today, on the open, a trader bought another 4,500 of these calls for prices ranging from $0.45 to $0.55. And shortly after I sent my alert this afternoon, a trader paid $0.20 for 1,000 December 10 calls that expire in two weeks.
If ONNN gets taken over or surges significantly higher, buying the calls outright will have been the right trade.
On the other hand, if ONNN is range-bound or drifts slightly lower or higher, the buy-write will be the right trade.
What pushed me to the buy-write in this case was the explosion in the price of the option. Because of the significant pop in volatility/price, the option appears to be grossly overpriced. And with a buy-write, I could make money two ways: If the stock goes up, I would profit, and if the options price becomes more “normalized,” I would profit.
Why do I say the option is overpriced? Think of a one-dollar bill. If someone walked up to you and said “I’ll sell you a one-dollar bill for $1.05" would you buy the one-dollar bill? What if the person said, “I’ll sell you a one dollar bill for $1.20?” That’s an even worse deal. This is of course a metaphor for how options sometimes get mispriced. Once this seller of the one-dollar bill can’t sell it for more than it’s worth, the price will revert to its true value, or $1. And that’s what I believe will happen to this ONNN option.
As I said, if ONNN gets taken over or explodes higher in price, than the call purchase would have been the better approach.
If you prefer to buy calls, that’s certainly your choice. However, in this case, I believe executing the buy-write is the better tactical trade.