In a sense, trading options versus stocks, essentially gives you a way to lease stocks over a certain length of time for just a small fraction of what the stock would otherwise cost to buy. This enables you to free up more of your trading capital which can then be used for other trading opportunities.
So, if you have ever wanted to participate in the trading of stocks like Microsoft, JP Morgan Chase & CO., or ExxonMobile, but didn’t have enough cash to do so… now you can by trading the underlying options.
Let’s see how much it would cost to buy the options of the following companies instead of buying the stock. In this example, we will use call options that are approximately “at-the-money” having long-term expiration dates to make it more like stock ownership.
(option info taken on close of 08/10/16)
Microsoft:
- Buy 1 call option contract at $5.80 = $580
- $57.50 strike price
- 527 days to expiration
- Buy 100 shares at $57.97 = $5,797
JP Morgan Chase & CO:
- Buy 1 call option contract at $6.70 = $670
- $65.00 strike price
- 527 days to expiration
- Buy 100 shares at $65.22 = $6,522
ExxonMobile:
- Buy 1 call option contract at $8.55 = $855
- $85 strike price
- 527 days to expiration
- Buy 100 shares at $86.70 = $8,670
Options make it much more affordable to participate in the trading in these companies without having to take such a large bite out of your trading capital. And, look at the amount of time that you get with these options of the underlying stock for it to make a move in your favor – a whopping 527 days!
A Brief Summary Of Call Options
Buying a call option gives you the right (not the obligation) to purchase a certain amount of shares of a company’s stock at a certain price on or before a certain date.
One option contract is equivalent to controlling 100 shares of the underlying stock. Two option contracts is equivalent to controlling 200 shares of the underlying stock (so on and so forth).
Each option has its own strike price which, depending on the relationship it has to the price of the underlying stock, can be “in-the-money,” “at-the-money” or “out-of-the-money.”
With trading options, you are free to choose whatever length of time you think will be necessary to fit your option trading strategy which can range from a day to several years away. Options with expiration dates longer than nine-months are known as “LEAPS” (Long-term Equity AnticiPation Securities).
When buying options (call options) you can forgo the right to buy the stock and just sell the option outright at any time on or before the expiration date to take any potential profits.
Trading options can give you a much higher rate of return on your money in a faster period of time than you can get from trading the underlying stocks.
This is because options are leveraged financial instruments. However, of course, the risks and rewards of trading options are different than those of trading stocks. It is strongly advised that you clearly understand the risks and rewards of the type of financial instruments that you will be trading including options if applicable.
(To get a better understanding about options, click on Learn Options Trading)
Let’s Go Shopping For Options
Let’s see what kind of options (call options) we can get for our money. Let’s look at a company like Abbott Laboratories (Stock Ticker: ABT) as an example:
(option info taken on close of 08/10/16)
- Stock Price $44.77
- Cost to Buy 100 Shares = $4,477
| Days to Option Expiration | 100 Days | 163 Days | 527 Days |
| Cost of Options » | |||
| Strike Prices: | |||
| $43 (I-T-M) | $280 | $335 | N/A |
| $44 (I-T-M) | $213 | $271 | N/A |
| $45 (A-T-M) | $157 | $214 | $425 |
| $46 (O-T-M) | $111 | $165 | N/A |
| $47 (O-T-M) | $76 | $125 | $330 |
Just by looking at this brief and limited comparison, we can see that the cost of the different options are much cheaper across the board than the cost of buying the stock of Abbott Laboratories outright.
Quick observation as to the price of the Abbott Laboratories call options:
- The “in-the-money” call options are more expensive than either the “at-the-money” or “out-of-the-money” options
⚐ This is mainly due to the fact that “in-the-money” options command a higher price since they have intrinsic value (real value) and have relative higher deltas which makes the options perform more like the actual performance of owning the underlying stock.
(see option greeks for an explanation of delta)
- Options having longer-term expiration dates are more expensive than ones having shorter-term expiration dates since this gives you more time to be right for the projected move of your trade to be favorable.
Option Cost Versus Stock Cost = Opportunity Cost
Because the cost of buying options is a small fraction to the cost of buying the underlying stock, it brings up another kind of cost issue – “opportunity cost.”
Let’s use the Abbott Laboratories example above…
To buy 1,000 shares of Abbott Laboratories stock it would cost you $44,770 (assuming not bought on margin and ignoring commissions)
To buy 10 “at-the-money” option contracts with 527 days left to expiration it would cost you $4,250 (buying 10 option contracts would be equivalent to controlling 1,000 shares).
The excess cash balance left over from buying the 10 option contracts instead of buying 1,000 shares of Abbott Laboratories stock would be $40,520. This amount ($40,520) represents the opportunity cost.
What would you do with it?
You could buy numerous option contracts on stocks in completely different companies and industries (to the extent allowed by your option trading budget) compared to holding a single stock position in just one company.
Or, you could do a mixture of the two – buy a combination of options and stocks in different companies and industries to help diversify (reduce risk) as well as potentially getting a higher rate of return due to the leveraged position of the options than by just owning one stock.
