Strategies in Buying Calls I
Are you interested in learning some strategies on how to maximize your call options by either profiting more or at the very least minimizing losses? If you are, then read on as I present to you some strategies you can employ using call options. Note, however, that for purposes of simplicity, tax considerations, commissions as well as transaction costs have been omitted in my illustrations. Also, the call options here are assumed to be American style, which means that the call option can be exercised any time before the expiration period.
One of the reasons why investors buy call options is to benefit from a particular increase in the underlying stock prices. Profits can be obtained from an increase in stock prices in two ways: by exercising the stock option outright or by closing your position as holder and selling your call option. To help you understand this strategies let us assume that you bought Stock A $50 July call option. This means that for the option premium of $3.50 per share ($350 for 100 shares), you as the holder has the right to buy 100 shares of Stock A for $50 each ($5,000 total) before the option’s expiration in July. Let us assume that before your stock option expires, the price of Stock A skyrockets to $55 per share and the prevailing premium also increases to $5.50. What can you do to profit?
You have two options to benefit in the increase of Stock A’s price. You can exercise your call option outright and buy 100 shares of Stock A for $5,000 (for a total cost of $5,350 including the option premium of $350) and re-sell these stocks for $5,500 making a net profit of $150 ($5,500 � $5,350). The other way to gain money and to yield more profit is to close your position as holder and sell the call option. Sell your option contract at the prevailing premium of $5.50 for a total of $550 for the 100 shares of Stock A. If you do this you gain $200 ($550 – $350). If you exercise your call option and re-sell Stock A you would only yield a 10% profit whereas if you close your position and sell the call option you yield a 57% profit, a 47% difference in profits.
Bear in mind, however, that the price of the premium is influenced by the remaining time before the stock option expires. The nearer the expiration of the stock option, the lesser the option premium becomes. You may also be influenced by how much you want to keep those stocks.
If in our example the price of Stock A does not increase but instead decreases to $45 per share and the option premium plummeted to $.90, you can still choose to lessen your losses by selling your stock option. Instead of losing your whole $350, by selling your call option, you lose only $260 ($350 – $90). In most call options, the loss by buying an option is lesser than by buying the shares of stock outright. In this case you lost only $260 but if you had bought Stock A outright you would have lost $500.