 Buying Calls Option Strategy
The most basic option strategies involve buying calls or
puts, depending on your market view.
When you are very bullish on the market, you can buy calls
to profit from an upward movement that occurs while you own
the option.
A call is the right, but not the obligation, to purchase an
asset at a specific price (the strike price), on or before
a specific date (the expiration date).
For example, suppose XXX Corp. is presently trading at $77.
per share. If you expect the price to increase
significantly over the next couple of months, you could
purchase a call option to greatly leverage your profits
from the expected movement. At present prices, you could
purchase a call with a strike price of $75 and an
expiration date a couple months out for about $7.50. If you
are correct and XXX trades at $90. during the couple
months while you are holding the option, the price of your
option will more than double during that time period
because the option will be priced at least $15. (anyone
holding that option has the right to buy XXX at $75.,
but they can sell it at the current price of $90., yielding
a $15. profit).
Although the underlying asset price increased less than
17%, your option on that asset increased by 100% or more.
That's the leverage that options provide.
When you buy a call, your profit potential is unlimited. No
matter how high the underlying asset price rises before
expiration of your option, you reap the profits from that
increase. Yet, your risk is limited. If the underlying
asset price drops by $20, the most you can lose is the
price that you paid for the option. In the example above,
if Microsoft drops to $57, the most you can lose is the
price you paid. In this case it would be $7.50 per
controlled share.
The person who sold you the option actually holds the
underlying asset, so they would absorb the rest of the
loss.
When we purchase calls, we generally purchase them at-the-
money or in-the-money, because it lowers our risk of losing
the premium. Although out-of-the-money options are much
cheaper and provide greater leverage, there is a greater
risk of loss. We generally buy them several months out to
provide enough time for the market to make the anticipated
move.
Options are not like stocks where you buy them and hold
them. Decay will continually erode your position and a
change in trend can evaporate your profits quickly. It is
important to set a specific target price for the option
when you initiate the position. When we reach our target,
we sell and take our profits. Beware that greed can be a
strong motivator and make you want to increase your price
target as it is rising. However, doing that can sometimes
turn a winning position into a losing position.
It is important to analyze your expectations for the
underlying asset and for the market before selecting your
strategy.
When you are analyzing potential option positions, it
helps to have a computer program like Option-Aid that
swiftly calculates volatility impacts, probabilities,
statistics, and other parameters of interest. These
programs can pay for themselves with the first trade that
they help you with.
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Related financial Sites:
Valuation of Company Options
Option Posting Service for Companies
Valuation of Employee Options
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