In the money Call Options question (new to options)?

Question

I am studying options. For example INTC (intel) is at 21.91 close today. And I am looking at Jan 09 call at $10 strike . My thinking is that instead of buying stock at 21.91, its better to buy call of $10/strike for 12.50. i.e I am paying only 60 cents premium for 2 years (over the current stock price).

For 22.50 strike price the premium is $3.

If the stock rises then I make the same amout of money as $22.50 (and more as I spent less premium). And if the stock goes below 23.50 I loose all money with $22.50 strike option. Aka (22.50 + prmium of $3)

The spread (wrong tech term) for $10 option to make money is above 21.91.

Am I on wrong track ??? Any advice please.

Sorry above the number is 25.50

Answer 1

Think of it in terms as a return on your investment. If you bought the 10 strike at $12.00 and the stock went to $30, then you would have a profit of $8.00 or 67%. If you bought the 22.50 strike at $3.00 and the stock went to $30, then you would have a profit of $4.50 or 150%

The breakevens would be $22.50 for the 10 strike (10+12.50) and $25.50 for the 22.50 strike (22.50+3).

Whatever you buy is at risk, so buying the $12 option and you risk $12, buy the $3 option and you risk $3.

It all really depends on what you can handle for risk and how much you want to leverage your investment.

As a side note, you might only be paying $ .60 for the "premium", but you will still pay all of the $12.50 for the option.

Answer 2

There is some good advice in here already, but I would like to make one suggestion: long options are a depreciating asset i.e. the contracts lose value over time. Two years is a long time. You might want to look at a more advanced strategy with a postive Theta like a calendar spread which will both capture that depreciation as well as profit from directional movement of the underlying.

Here's how it works if you're bullish on the underlying stock:

First find out what one standard deviation is from the current price. Take the Volatility * the current trading price * square root of (days until expiration/365) and add that value to the current price to determine your strike. For example, INTC is trading at $21.91 and the volatility is 31.72%. For a Jan 08 LEAP, that would be .3172 * $21.91 * sqrt(271/365) = $5.98 + 21.91 = $27.5 Strike

Now that you've determined which strike price to use, you will sell the near month and buy long the far month. In the case of leaps, you would sell a Jan 08 $27.5 Call and buy a Jan 09 $27.5 call.

The advantage of this strategy is simple. Because the near month strike depreciates faster than the far month strike, you'll still make money even if the price of the underlying doesn't move at all. This allows more margin for error. You can make money by time passing, or by the price of the underlying going up moderately, whereas buying a option long only profits if the underlying goes up in value.

Check out the options calculator linked below.

Answer 3

Let's start with an overly simplistic comparison. Assume three people each wanted to invest $7,500 in a bullish INTC position.

Andy buys 6 2009 LEAPS with a strike of $10.00.

Betty buys 25 2009 LEAPS with a strike of $22.50.

Carol buys 342 shares at $21.91.

All three of them hold their positions until the 2009 LEAPS expire. Now let's look at what their profit (loss) would be at several different stock prices.

If the stock is at $15.00

Andy would lose $4,500 (60%)
Betty would lose $7,500 (100%)
Carol would lose $2,363.22 (31.5%)

If the stock is at $20.00

Andy would lose $1,500 (20%)
Betty would lose $7,500 (100%)
Carol would lose $653.22 (8.7%)

If the stock is at $25.00

Andy would make $2,500 (33.3%)
Betty would lose $1,250 (16.7%)
Carol would make $1,056.78 (14.1%)

If the stock is at $30.00

Andy would make $4,500 (60%)
Betty would make $11,250 (150%)
Carol would make $2,766.78 (36.9%)

For every dollar above $30

Andy would make $600 (8%) more
Betty would make $2,500 (33.3%) more
Carol would make $342 (4.6%) more

The advantage of buying lower cost options is the leverage they provide if the stock makes a large move in the right direction. The disadvantage, of course, is that without that large move in the right direction the leverage creates (larger) losses.

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As I said at the beginning, that is an oversimplified example. The major reason is that most option traders will not simply buy a LEAPS option and hold it until expiration, and prior to expiration "implied volaility" can have as much, or more, impact on the option price as the stock price. It is unlikely that any professional option trader would buy the $22.50 strike LEAPS unless he thought the option price would increase due to an increase in implied volatility.

Another factor to consider is the "carrying cost" for the position. For simplicity let's assume the current interest rate is 6%. If you spend $1,250 for a call option 1.75 years away from expiration, you would not get paid interest on that $1,250 but the writer of the call would. Since 6% for 1.75 years is roughly 10.5%, your actual cost for buying the option (instead of placing the money in an interest bearing account) is roughly 1,250 x 1.105 = $1,381.25.

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If I read it correctly, in your question (with the correction) you indicated you would lose all your money on the $22.50 LEAPS call with the stock under $25.50. If that is what you meant, it is incorrect. If you held the option until expiration you would lose SOME money if the stock was below $25.50, but you would not lose ALL your money unless that stock was below $22.50.

Answer 4

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Answer 5

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Answer 6

Ofcourse, you are on the right track.