There is no doubt that handsome profits can be made from buying company stocks in rising market conditions, and then selling at a profit once the share price has increased. This strategy is called Stock Trading, and you may even know of someone who does this for a living?
Are you aware though, that there is a much more effective trading vehicle that can offer the trader greater profitability at a much smaller cost?
CALL OPTIONS
One of the many benefits of Stock Options is that when Options Trading, you can profit from them whether the stock price is going up (Call Options) or going down (Put Options).
Now you may argue that you can do the same with company stocks through buying and shorting shares, but there are several reasons why I prefer to use stock options over other trading vehicles:
1) Affordability
Call options allow us to control company stocks that would otherwise be quite expensive to own.
Stock Options cost a fraction of the price of the underlying stock but they represent the same amount of shares. So this means with Call Options you can actually profit on the same shares using a much smaller amount of money.
For example if XYZ shares were trading at $ 20 and you chose to buy 50 shares, your cost would be $ 1,000.
However an XYZ Call Option with a strike price of $ 20 might only cost you $ 1. So if you used the same $ 1,000 to purchase Call Options instead, you would have control over 1,000 of the same shares, not 50.
2) Leverage
The power of controlling and profiting from a larger investment with a smaller amount of money produces leverage.
With Call Options not only are you able to control more shares, but your profitability would be much greater than buying the actual stocks.
Using the above examples, Let’s say that XYZ shares increased to $ 40. If you had bought the 50 shares, you would be looking at a profit of $ 1,000.
But if you had purchased XYZ $ 20 Call Options to give you control over 1,000 shares and they were now worth $ 2.00, you would be looking at a profit of $ 2,000.
There are ways to precisely calculate the leverage of a Call Option and this is dependant on where the stock price is in relation to the option strike price.
For instance a call option that is ‘In The Money’ (Current Stock price is above the strike price) offers less leverage than a call option that is ‘Out Of The Money’ (current stock price is below the strike price).
3) Income
Stock Options can be Purchased or Sold. This offers the investor two ways to make money as income.
Writing Options – you can Write (or sell) a Call Option and profit from time decay. As an option draws nearer it’s expiry date, it loses value in time.
As a writer, you receive the premium, or purchase price of the option. When the opinion of the buyer of those stock options is wrong, the Call Option expires worthless and the option premium you received becomes your profit.
One thing to consider however, is that the buyer of a Call Option is not obligated to buy the underlying stock, but the Writer (or seller) of a Call Option IS obligated to sell the underlying shares should the option taker exercise their right.
Writing Calls on stocks you do not own can present an unlimited risk.
Options Trading – you can Take (or buy) a Call Option and on-sell the option to someone else.
This would be the most common strategy involving Stock Options. Options Trading with Calls is most profitable for the trader when the underlying stock price rises or rallies before the expiry date of the option.
As the share price increases, so too does the value of a Call Option and the trader on-sells the option to realize a profit.
Unlike the writer of a Call Option, when buying (or taking) call options you have no obligation to buy the underlying stock, so your maximum risk is limited to the amount which you paid for the option in the first place.
By: Jules Dawson About the Author:
