Schaeffer's Top Stock Picks for '25

Why You Should Use Options to Boost Your Portfolio

Options are attractive because of their low relative cost

Deputy Editor
Jul 5, 2024 at 12:05 PM
    facebook X logo linkedin


    Why buy calls when you can just buy the stock? It's an eternal debate plaguing many active investors, especially those contemplating a move into the derivatives market. But it is evident that more and more investors are supplementing their portfolios with options trading.

    So, what are the key differences between a traditional long stock play and a long call? Let's start with a stock position's advantages. The main one is the dividend payout, in which option buyers do not partake.

    Also, a stock trader is less likely to lose his or her total dollar investment than an option trader. But that total investment is typically bigger in terms of absolute dollars, and that's where the advantages of options come into play.

    Options are attractive because of their low relative cost, which goes hand-in-hand with the leverage they provide compared to their equity counterparts. With just a slight move higher in the underlying, the properly selected option can jump significantly, on a percentage basis. It is easiest to illustrate this with an example.

    • Stock XYZ is trading at $60
    • Stacy buys 100 shares for $6,000
    • Adam buys the in-the-money, back-month XYZ 57.50 call for $3.50 ($350 per contract)
    • XYZ rallies $4 to $64
    • The XYZ call is worth $6.50 at expiration
    • Stacy nets a profit of $400 on the stock (6.7%), while Adam nets a profit of $300 (85.7%) on the option

    In this example, Adam's $350 controls 100 shares of XYZ, just like Stacy's $6,000 investment in the stock itself. Adam could have bought additional contracts, which would improve his net dollar gain.

    Additionally, while $6,000 of Stacy's money is tied up in one stock, Adam could take the same amount of money and invest in multiple underlying issues by purchasing additional long calls (or puts). Now let's see what happens when the stock pick turns south.

    • Stock XYZ is trading at $60
    • Stacy buys 100 shares for $6,000
    • Adam buys the in-the-money, back-month XYZ 57.50 call for $3.50 ($350 per contract)
    • XYZ drops $3 to $57
    • The XYZ call is worth $0 at expiration
    • Stacy loses $300 (5%), Adam loses $350 (100%)

    In this example, Adam loses his full investment as his call expires out-of-the-money, while Stacy loses just $300 of her initial $6,000. But here's the difference: if something catastrophic happens and XYZ were to drop by $10, $20, or even $40, Adam's loss on the option will never be more than the premium he paid for the call (minus commissions, of course), while Stacy's stock position is vulnerable, theoretically, all the way down to the zero point.

     
     

    You have the chance to join one of Bernie's most exclusive programs, complete access at HUGE savings!

    As we prepare for a new administration to take the reins in Washington, the near-term market landscape is rife with uncertainty.

    The Federal Reserve has already hinted at the turbulence ahead, lowering its interest rate outlook for 2025.

    Meanwhile, breakthroughs in artificial intelligence (AI), quantum computing, and other transformative sectors have unlocked incredible profit potential.

    But these opportunities are fleeting, and timing is everything. That's where Quick-Hit Trader comes in.

    Quick-Hit Trader is designed for precision and speed, getting you in and out of the market in a flash. While other investors scramble to navigate volatile conditions, you'll have access to expertly curated trades that leverage these rapid shifts to deliver explosive profits in short order.

    This is your chance to capitalize on the fast-moving market like never before. Are you ready to make your move?