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