Daily Gains Letter

Call Options: My Top Investment Strategy to Manage Risk and Gain Leverage

By for Daily Gains Letter |

Call Options Top Investment StrategyUsing Call Options for Leverage and Risk Management

The other day I was thinking back years ago to one of the first handfuls of trades I undertook as a rookie trading the stock market.

The trade I executed was buying 10 call options contracts on Bank of America Corporation (NYSE/BAC). While I don’t recall the exact details of the trade as far as the strike price, premium, or the market price, what I remember was the leverage the option trade afforded me. I didn’t have enough cash to buy 1,000 shares of Bank of America, but I realized I could get a similar trade by buying 10 call option contracts. The trade paid off, I made some quick cash, and I was hooked on the options market.

Now many of you may not be familiar with call options, or options in general, but they are pretty straightforward as far as straight call options. Of course, there are more complex strategies, such as spreads, straddles, butterflies, ratios, and writing options, but I will focus on the use of call options as a starter.

Simple Investment Strategies Using Call Options

Call options are simply a leveraged bet on the stock moving higher by more than the premium paid for the option and commission by the expiry date of the contract.

If you are correct and the underlying stock or instrument moves above your breakeven, you walk away with good profits on the call option trade.

In the case that the stock doesn’t move above your breakeven for the call option trade by the expiry, you would lose the entire premium paid. This is your maximum risk, as you cannot lose more than the premium under a long call option. Now, if you sell a call option as an opening transaction, your losses would be only limited by the time to expiry.

As I said earlier, one of the major benefits of buying call options is the leverage provided to you. One call option contract translates into the right to buy 100 shares of the underlying stock at a fraction of the upfront cost if you had instead purchased the stock outright.

For example, take the case of Apple Inc. (NASDAQ/AAPL). To buy 1,000 shares of Apple, you would need to come up with about $120,020 based on its price of $120.02 on Wednesday. Furthermore, all of this capital is at risk. Now, to get a similar trade via options, you can alternatively buy 10 call options contracts on Apple (say the January 15, 2016 expiry), which equates to 1,000 shares. At the prevailing price, the cost of an at-the-money premium for the $120.00 strike is $12.10, or $12,100 for the 10 contracts, which is the maximum risk to you. The breakeven is when Apple moves to $132.12 per share by the expiry. The chart shows the profit-loss scenario at various prices. (Note: This is for illustration purposes only and is not meant to be a trade recommendation.)

Apple Call Options Profit and Loss Chart

Keep in mind that call options do not have to be kept until expiry; rather, any option position can be offset in the open market prior to the expiry date.

The Call Options Market

The options market and call options are vast and available for all S&P 500 and DOW stocks, along with many Russell 2000 and NASDAQ stocks. You can take a look at the Chicago Board Options Exchange for more information.

Some of the more popular options traded include Apple, Bank of America, Facebook, Inc. (NASDAQ/FB), JPMorgan Chase & Co. (NYSE/JPM), Citigroup, Inc. (NYSE/C), Tesla Motors, Inc. (NASDAQ/TSLA), and Microsoft Corporation (NASDAQ/MSFT).

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