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474 Part IV: Additional Considerations 
arbitra:ry requirements would be including only calls that sell for one point or more, 
or stating that the downside protection must be a certain percentage of the stock 
price. These obviously cannot suffice for stocks with different volatilities. Rather, 
the downside protection criterion should be stated in terms of "probability of down 
protection" or, alternatively, in terms of the volatility itself. In this manner, a uniform 
comparison can be made between volatile and nonvolatile stocks. 
CALL BUYING 
The option buyer can also constructively use the measurement of volatility to aid him 
in his option buying decisions. In Chapter 3, it was shown that evaluating the prof 
itability of calls based on the volatility of the underlying stock is the correct way to 
analyze an option purchase. One specific method of analysis is described. There are 
certain variables in this analysis that may be altered to fit the call buyer's individual 
preferences, but the general logic is applicable to all cases. 
As a first step, one should decide upon a uniform stock rrwvement for ranking 
call purchases. One might decide to rank all purchases by how they would perform 
if the underlying stock moved up in accordance with its volatility. The phrase "in 
accordance with its volatility" must be quantified. For example, one might decide to 
assume that eve:ry stock could move up one standard deviation, and then rank all call 
purchases on that basis. The prospective call buyer must also fix the time period that 
he wants to use. Generally, one looks at purchases to be held for 30 days, 60 days, and 
90 days. 
The exact steps to be followed in the analysis of profitability and risk can be list­
ed as follows: 
I. Specify the distance that underlying stock can move, up or down, in terms of its 
volatility. 
2. Select the holding period over which the analysis is to take place. 
PROFITABILITY 
3. Calculate the stock price that the stock would move up to, when the foregoing 
assumptions are implemented. 
4. Using a pricing model, such as the Black-Scholes model, estimate what the 
option price would become after the upward stock movement. 
5. Calculate the percent profit, after deducting commissions. 
6. Repeat steps 4 and 5 for each option on the stock.