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Chart of the Day / Education: When to Buy Call Options

Education: When to Buy Call Options

September 24, 2018

Options are just another way to trade stocks.

But instead of buying a stock, you’re buying what’s referred to as a contract.  These give you the right – but not the obligation – to ever hold actual stock, sell or buy it.

Options are also available in what’s known as call and a put.

A call is a bet that the value of the actual stock will move higher.  If it moves higher, my option will increase in value.  A put is a bet that the value of the actual stock will move lower.  If it moves lower, my option will increase in value.

Call Options 101: When to Buy

The best time to buy a call is when you believe a stock will move higher.

For example, in August 2018, look at Electronic Arts (EA).

In recent months, the stock fell after the company delayed the release of Battlefield V to November 20, 2018. Then. It lowered its full-year guidance on the delay. While part of that lowered guidance was because of the game’s delayed launch, EA said $115 million of the change was because of revised expectations regarding foreign-exchange rates, according to The Wall Street Journal.  It’s why the stock plunged from $135 to $110 in recent weeks.

Technically, it became oversold at its lower Bollinger Band (2,20) with oversold extensions on RSI, MACD and Williams’ %R. 

Let’s say I believed EA could move higher from this point.  I would have two choices.  One, I can buy the stock, which traded at $114 a share.  If I wanted to buy 100 shares, it would cost me $11,400.  Or, two, I can buy a call option, which gives me the right, but never the obligation to own 100 shares of EA.  That’s because one contract carries 100 shares.

Let’s now say I believe EA can move above $115 a share prior to November 16, 2018, the expiration date for November 2018 options.  I can buy an EA November 16, 2018 115 call at $550 (current price of option x 100 shares).

The best part – I never have to take ownership of EA stock at all.

Better yet, instead of paying $11,400 for 100 shares, I can pay $550.

Let’s now say, EA moved to $120 a share, bringing my initial investment of $11,400 to $12,000.  I just made 5%.

However, the EA November 16, 2018 115 call carries a delta of 51 cents. That means for every $1 move higher in EA, my call option adds 51 cents.  So, if EA moves up $6, my call options pick up $3.06.  My $5.50 call now becomes $8.56 for a gain of 180%.

I’d say a 180% win is much better than a 5% win, wouldn’t you?

That’s just one of many reasons why options are a better choice than stocks.