|
I will use IBM stock for bullish and bearish
examples throughout this column.
By the end of Monday May 11, 2009, the call option
chain for IBM stock for the month of October will most likely look like
the following table:
|
Oct. 09
|
|
Call
|
Option
|
Chain
|
for
|
IBM
|
stock
|
|
|
|
|
|
|
IBM
|
102.90
|
1.41
|
|
Calls
|
|
|
|
|
|
|
Strike
|
|
Symbol
|
Last
|
Change
|
Bid
|
Ask
|
Volume
|
Open Interest
|
Price
|
|
IBMJS
|
13.60
|
1.40
|
13.00
|
13.30
|
32
|
750
|
95
|
|
IBMJT
|
10.10
|
0.60
|
10.00
|
10.20
|
25
|
1864
|
100
|
|
IBMJA
|
7.60
|
0.70
|
7.40
|
7.60
|
238
|
5818
|
105
|
|
IBMJB
|
5.46
|
0.56
|
5.30
|
5.50
|
34
|
16665
|
110
|
IBM stock traded at $102.90/share, a gain of
$1.41/share from the previous trading day.
After analyzing the stock, we are bullish about
IBM and expect the stock to pick up $3.00/share in about three months. We
have a choice here: We can either buy the stock or buy a call option.
If we buy 100 shares IBM stock at $102.90/share
and the stock rises to $105.90/share on August 11th, we make
$300 profit, a 2.92% gain in about 3 months based on $10,290 initial
investment.
Instead of buying the stock, we can buy the call
option since call option moves in the same direction of the underline
stock. For the sake of simplicity, let’s assume near-the-money call
option has 0.50 delta and it moves $0.50 for
every $1.00 of the stock’s movement. Let’s say we buy 1 contract
near-the-money call option IBMJT for $10.10/share or $1,010/contract. If
we are correct in our forecast of IBM stock, the stock rises to
$105.90/share on August 11th and the call option is worth
roughly $11.60/share or $1,160/contract. We make $150 profit, a gain of
14.85% in about 3 months based on $1,010 initial investment.
We can see trading option has great leverage
here. If we are bullish about a stock, buying a call option gives us much
bigger percentage gain (14.85% vs 2.92%) with a lot less capital ($1,010
vs $10,290). Recalling the Option Chain and Option Premium lessons, we
notice that ITM options have mostly intrinsic value with very little time
value. In fact, the deeper ITM option, the more intrinsic value and the
less time value it is. For beginner, it is always a good idea to buy ITM
option and buy more time. If we believe the stock needs 3 months to move
to our target price, buy more than 3 months time. In this example, we buy
about 5 months time. The rule of thumb: When in doubt, buy more time. We
can always get back the left over time value when we liquidate our option
position. However, skillful and experienced option traders tend to buy
ATM or even OTM option and buy less time to increase return percentage
and to make the most of option leverage.
Dennis Phan 潘家墉
20 May 2009
|
