Cl,opter 3: Call Buying 97 
RISK AND REWARD FOR THE CALL BUYER 
The most important fact for the call buyer to realize is that he will normally win only 
if the stock rises in price. All the worthwhile analysis in the world spent in selecting 
which call to buy will not produce profits if the underlying stock declines. However, 
this fact should not dissuade one from making reasonable analyses in his call buying 
selections. Too often, the call buyer feels that a stock will move up, and is correct in 
that part of his projection, but still loses money on his call purchase because he failed 
to analyze the risk and rewards involved with the various calls available for purchase 
at the time. He bought the wrong call on the right stock. 
Since the best ally that the call buyer has is upward movement in the underly­
ing stock, the selection of the underlying stock is the most important choice the call 
buyer has to make. Since timing is so important when buying calls, the technical fac­
tors of stock selection probably outweigh the fundamentals; even if positive funda­
mentals do exist, one does not know how long it will take in order for them to be 
reflected in the price of the stock. One must be bullish on the underlying stock in 
order to consider buying calls on that stock. Once the stock selection has been made, 
only then can the call buyer begin to consider other factors, such as which striking 
price to use and which expiration to buy. The call buyer may have another ally, but 
not one that he can normally predict: If the stock on which he owns a call becomes 
more volatile, the call's price will rise to reflect that change. 
The purchase of an out-of-the-money call generally offers both larger potential 
risk and larger potential reward than does the purchase of an in-the-money call. 
Many call buyers tend to select the out-of-the-money call merely because it is cheap­
er in price. Absolute dollar price should in no way be a deciding factor for the call 
buyer. If one's funds are so limited that he can only afford to buy the cheapest calls, 
he should not be speculating in this strategy. If the underlying stock increases in price 
substantially, the out-of-the-money call will naturally provide the largest rewards. 
However, if the stock advances only moderately in price, the in-the-money call may 
actually perform better. 
Example: XYZ is at 65 and the July 60 sells for 7 while the July 70 sells for 3. If the 
stock moves up to 68 relatively slowly, the buyer of the July 70 - the out-of-the­
money call - may actually experience a loss, even if the call has not yet expired. 
However, the holder of the in-the-money July 60 will definitely have a profit because 
the call will sell for at least 8 points, its intrinsic value. The point is that, percentage­
wise, an in-the-rrwney call will offer better rewards for a rrwdest stock gain, and an 
out-ofthe-rrwney call is better for larger stock gains.