Options Trading Strategy:
Buying Calls
Buying calls or puts are the most popular options
trading strategies among retail traders. There are no margin requirements for
this type of trading and an options investor can try buying calls with a
relatively small portfolio.
If an options trader is expecting the market to go up
he/she can buy calls with expectations to profit from a bullish movement. A
call gives to the owner the right, but not the obligation, to buy an asset
at a specific price (the strike price), on or before a specific date (the
expiration date). If the price of the underlying stock goes up, the call
price goes up. If the price of the underlying stock goes down, the call
price goes down.
For example, if you buy a QQQQ options calls at $2.00 and
the next day QQQQ stock raise 1%, your calls may increase in value by 20%.
You may then decide to sell the calls and fix a 20% profit, or if your view
on the market is still strongly bullish you may decide to wait and sell the
calls later, in expectation of bigger profits. On the other hand, if after
buying QQQQ call options the QQQQ stock goes down, then the value of the
bought call options will decrease.
An options buyer should always be aware that time plays
against him. Even if the market moves flat, the value of the calls may drop
within a couple of days. The closer to expiration the calls are the more
sensitive then they are to the time factor. When you buy call options you
cannot hold them as stocks. Options loose their value with time - the closer
they are to the expiration, the cheaper they become. When a trader initiates
the position, it is important to set a specific target price for the option
and it is a good strategy to sell and take profits, when the price reaches
the target. As the price is rising, be careful that greed does not become a
too strong of a motivator and make you want to increase your price target.
Doing this, a trader can sometimes turn a winning position into a losing
position.
The maximum loss a call options buyer may experience is
100% of the amount invested in the call options. The potential profit is
theoretically unlimited.
Depending on the trading style and risk tolerance, an options buyer may
chose to buy different types of call options that may vary by strike and
expiration. The most traded options are nearest in the money call options.
They are considered more or less safe and the reaction of the options price
to the changes in the price of the underlying stock is still big. The deeper
in the money call options are considered more conservative; however, they
are more expensive. The cheaper (out of the money) call options are
considered more risky and the cheaper (more out the money) they are, a
bigger move in the underlying stock is required to trigger changes in the
call price.
For instance:
If at the current moment the QQQQ stock is traded at
$44.56
- the $44
strike call options are nearest in the money options and may cost
$1.50
- the $36
strike call options are deep in the money options and may cost $4.00
- the $45
strike call options are nearest out the money options and may cost
$1.00
- the $48
strike call options are deep out the money options and may cost
$0.05
Now, if the QQQQ go up by 1% the value of the $44 and
$45 strike call options may increase by 20%, the value of the $36 strike
put options may increase by 15% and the value of the $48 strike options
will most likely remain unchanged. Since the QQQQ options price changes
by $0.05 it may require a 5% QQQQ raise to increase the value of $36
strike put options from $0.05 to $0.10 (by 100%) and time is not on the
side of the put buyer...
Another parameter that a put options buyer has to define
is options expiration. The closer to the expiration the cheaper call options
are, however, they are very sensitive to time and they are considered more
risky. As a rule 2-3 month expiration options are considered more
conservative and the price of these options are not critically affected by
the short period of time.
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