38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
96 Part II: Call Option Strategies
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Example: Assume that XYZ is at 48 and the 6-month call, the July 50, is selling for
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3. Thus, with an investment of $300, the call buyer may participate, for 6 months, in
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a move upward in the price ofXYZ common. IfXYZ should rise in price by 10 points
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(just over 20%), the July 50 call will be worth at least $800 and the call buyer would
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have a 167% profit on a move in the stock of just over 20%. This is the leverage that
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attracts speculators to call buying. At expiration, if XYZ is below 50, the buyer's loss
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is total, but is limited to his initial $300 investment, even if XYZ declines in price sub
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stantially. Although this risk is equal to 100% of his initial investment, it is still small
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dollarwise. One should nornwlly not invest more than 15% of his risk capital in call
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buying, because of the relatively large percentage risks involved.
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Some investors participate in call buying on a limited basis to add some upside
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potential to their portfolios while keeping the risk to a fixed amount. For example, if
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an investor normally only purchased low-volatility, conservative stocks because he
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wanted to limit his downside risk, he might consider putting a small percentage of his
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cash into calls on more volatile stocks. In this manner, he could "trade" higher-risk
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stocks than he might normally do. If these volatile stocks increase in price, the
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investor will profit handsomely. However, if they decline substantially - as well they
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might, being volatile - the investor has limited his dollar risk by owning the calls
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rather than the stock.
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Another reason some investors buy calls is to be able to buy stock at a reason
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able price without missing a market.
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Example: With XYZ at 75, this investor might buy a call on XYZ at 80. He would like
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to own XYZ at 80 if it can prove itself capable of rallying and be in-the-money at expi
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ration. He would exercise the call in that case. On the other hand, if XYZ declines in
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price instead, he has not tied up money in the stock and can lose only an amount
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equal to the call premium that he paid, an amount that is generally much less than
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the price of the stock itself.
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Another approach to call buying is sometimes utilized, also by an investor who
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does not want to "miss the market." Suppose an investor knows that, in the near
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future, he will have an amount of money large enough to purchase a particular stock;
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perhaps he is closing the sale of his house or a certificate of deposit is maturing.
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However, he would like to buy the stock now, for he feels a rally is imminent. He
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might buy calls at the present time if he had a small amount of cash available. The
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call purchases would require an investment much smaller than the stock purchase.
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Then, when he receives the cash that he knew was forthcoming, he could exercise the
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calls and buy the stock. In this way, he might have participated in a rally by the stock
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before he actually had the money available to pay for the stock in full. |