Buying Call Options.

15 May 2009 by Chetan Shah.

Lately I have been hearing that “buy and hold” is dead. I am not sure whether I am completely sold on that thought but I do believe in keeping small (10% or less) portion of my investing funds assigned to short term trading. Before my “options” days I used to buy a stock outright and then sell it when it fetched me a pre-determined profit margin. Thus if the stock price was $10, it would have costed me $1000 to buy 100 shares. I would sell it when it hits $15 thus making a $500 profit due to this transaction. i. e. : 50% return.

From options perspective it is all about “differences”. Please refer to my options blog to get an overview of what call and put options mean.

Therefore in this scenario, if the call option for this stock is trading at a $1 I would be able to buy 10 contracts (each contract comprises of 100 shares). If the stock hits $15, the option value will rise by $4 thus making it a $5 value option. Since I bought 10 contracts, my profit will be $4000 as compared to $500 if I had bought the stock outright. Taking the options route I was able to get a 400% as compared to a meagre 50% by taking the stock purchase route.

Caution :
1. This strategy only works when you are buying a stock to sell it in a short time period.

2. Options do expire at a predetermined date. If the stock goes down below the strike price then the option is worthless and you will end up losing the entire ($1000 in the above example). If you had taken the stock route, atleast you will be holding the stock and have a chance to recuperate your losses in future.

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