104 Part II: Call Option Strategies 
NVS: 40 VVS: 40 
NVS July 40 call: 2 VVS July 40 call: 4 
If these two calls are ranked for buying purposes, based strictly on a percentage 
change in the underlying stock, the NVS call will appear to be the better buy. For 
example, one might see a list such as "best call buys if the underlying stock advances 
by 10%." In this example, if each stock advanced 10% by expiration, both NVS and 
WS would be at 44. Thus, the NVS July 40 would be worth 4, having doubled in 
price, for a 100% potential profit. Meanwhile, the WS July 40 would be worth 4 also, 
for a 0% profit to the call buyer. This analysis would lead one to believe that the NVS 
July 40 is the better buy. Such a conclusion may be wrong, because an incorrect 
assumption was made in the ranking of the potentials of the two stocks. It is not right 
to assume that both stocks have the same probability of moving 10% by expiration. 
Certainly, the volatile stock has a much better chance of advancing by 10% ( or more) 
than the nonvolatile stock does. Any ranking based on equal percentage changes in 
the underlying stock, without regard for their volatilities, is useless and should be 
avoided. 
The correct method of comparing these two July 40 calls is to utilize the actual 
volatilities of the underlying stocks. Suppose that it is known that the volatile stock, 
WS, could expect to move 15% in the time to July expiration. The nonvolatile stock, 
NVS, however, could only expect a move of 5% in the same period. Using this infor­
mation, the call buyer can arrive at the conclusion that WS July 40 is the better call 
to buy: 
Stock Price in July 
VVS: 46 (up 15%) 
NVS: 42 (up 5%) 
Coll Price 
VVS July 40: 6 (up 50%) 
NVS July 40: 2 (unchanged) 
By assuming that each stock can rise in accordance with its volatility, we can see that 
the WS July 40 has the better reward potential, despite the fact that it was twice as 
expensive to begin with. This method of analysis is much more realistic. 
One more refinement needs to be made in this ranking process. Since most call 
purchases are made for holding periods of from 30 to 90 days, it is not correct to 
assume that the calls will be held to expiration. That is, even if one buys a 6-month 
call, he will normally liquidate it, to take profits or cut losses, in 1 to 3 months. The 
call buyer's list should thus be based on how the call will peiform if held for a realis­
tic time period, such as 90 days.