Bullish? What to Trade
Jul 19, 2010

I'm Bullish (Bearish): What Can I Trade?

Let's say you decided to take a long position in a given stock, but prefer not to buy ~10 shares with your $500 of available cash.

Let's also assume that you don't want to gamble and are not using options in an attempt to turn $500 into a quick $2,000 profit.  Why assume that?  Your group is an investment club, not a gambling club or a 'let's take a lot of risk for a quick buck' club.

What are some investment alternatives?

1) Buy on in-the-money (ITM) call option.  This can be a bit tricky.  You want to buy an option that is ITM by several points.  The idea is to own an option that is as similar to stock as you can.  However, if it is too far ITM, you will not be able to afford to buy the option, and if it is not far enough ITM, then you pay too much for time premium.
Your stock is $53.
But one call, expiring in 2 or 3 months
Strike price $50
Estimated premium (premium = price and depends on several variables): $400 to $500

Note:  The call with a $45 strike price is ITM by $8 and costs as least $800.  This is a better purchase for your purposes - if you have the available cash.

Your goal is to sell this call option at some time before expiration arrives.  The longer you own it, the more you are going to lose in time decay. 
Time decay?  This option is ITM by $300.  ($53 stock price minus $50 strike price).  The option cost that is above $300 in this example represents time decay.  All of that extra $100 to $200 goes away as time passes.  The reason people pay this money is to be able to control 100 shares of stock for far less than $5,000.
Have a plan.  Don't buy this and sit on it.  Try to decide, in advance, your profit target (don't forget commissions which can be high when you trade only one option at a time).  You can assign a club member to watch the option and enter a sell order at the appropriate time.  Or you can enter a GTC (good til canceled) order to sell if and when your rice is reached.  There are other choices (GTW - good for the week), but do not forget you own this option.

Part of the plan is to limit losses.  If the stock moves lower, or too much time is passing, you may want to sell the option to limit losses.

Good news:  The chance to earn far more than you would owning 10 shares.

Bad news: The chance to lose far more than you would owning 10 shares.

Be careful with this play.  It is short term in nature, unless you decide to pay to own an option that expires in a year or two (those are LEAPS options).  That;s viable, but requires payment of a substantial time premium.  If you love the stock and want to remain investors this is a reasonable alternative.
To be continued...

Mark D Wolfinger

Expiring Monthly: The Option Traders Journal