Part 1: How Options Work
Part 2: Stock Options vs. Stocks
In Part 1 of the Options Investing series, I outlined some basic principles to help you understand how options investing works.
In this post, I will help you understand just how much more profitable options trading can be than buying stocks.
We’ll start with a chart of Apple…
I purchased my $100 strike 2017 expiration call option on Jan 16, 2015 when Apple’s stock was trading around $106.
Call Option cost = $22 USD
Call Option Bid (Market Value) = $37 USD (+ 68.2%)
Stock Price = $106
Current Price = $132.54 (+ 25%)
Note: Call option bid price and Apple stock current price is as of May 22, 2015.
As you can tell, if I had bought Apple shares I would have only made a 25% gain to date. Don’t get me wrong, 25% in 4 months isn’t bad at all, but I invest using call options because I know how profitable options can be. As a result, I’m sitting on a 68% gain instead.
Options investing is a sweet feeling when it goes your way, but you always need to remember to manage your risk. This is even more true when you invest or trade using stock options.
Stock options produce huge gains as a result of leverage, delta (approx. $ change in the stock option for every $1 change in the underlying stock), and implied volatility.
Need more convincing on the profitability of stock options? Read this article where a trader purchased call options on Disney and made millions in profits.
In June 2014 the trader bought 50,000 out of the money call options with a $100 strike set to expire April 2015. The trader paid approx. $8.5 million according to the article, with a cost of about $1.75 for each option. When the stock options were purchased, Disney was trading around $85 and when the options expired Disney stock closed at $106.69 (the call options were in the money). The trade was worth $34 million for a profit of $25.5 million.
Now for the simple comparison (in order for 50,000 options to cost $8.5 million, each contract must be $1.70):
Call Option cost = $1.70
Call Option price (at expiration) = $6.80 (+ 300%)
Stock Price (when options were purchased) = $85
Stock Price (at expiration) = $106.69 (+ 25.5%)
Stock options provide superior returns.
Stay tuned on future posts in this series that I plan to publish:
- What you need in order to trade options
- Understanding Risk with Options
Fellow investors, remain disciplined and keep your cool!