Buy Stocks at No Cost Using Options
10/26/2011 1:30 pm EST
Geoffry Wong explains that by executing qualifying option trades, investors can enjoy the same profit potential as owning stocks while essentially putting none of their own capital at risk.
One popular strategy for traders who don't want to buy a stock that is too expensive or maybe don't have the biggest portfolio is to use options to take advantage of the movement. Our guest today is Geoff Wong to talk about that.
So Geoff, we always want to find the cheapest way to take advantage of movement in the market. Are options always the best way to do that?
I commonly like to buy options in lieu of stock; reason being that I can buy a stock a lot cheaper via options than buying the stock outright.
If I buy a stock outright, I can buy the stock and pay for it, or I can put it on margin and pay some implied interest rate, borrow the money, and have that interest rate; and that's a cost to me. But if I buy it via options, I no longer have to put up that money.
Example: Apple (AAPL) is trading at $325, so I want to go long Apple. I buy a 325 call and I sell a 325 put. Buying a 325 call makes me long; selling a 325 put also makes me long.
Being that options are a net-borrowing and lending market, if I buy the call, I put out money for that call. If I sell the put, I receive a credit.
Being that they are 50% Delta on both parts, which equal 100, that makes me long Apple stock. So I buy the call, I sell the put, and for almost zero premium.
It is not a strategy, but it is a way to replace buying a stock by buying a call and selling a put for almost zero cost.
See related: How Delta Affects Option Profits
It seems that the more that option is in the money, the more closely it will replicate the actual movement penny for penny or dollar for dollar of the actual stock. How far in to the money do I have to go to make that happen?
This you can do with at-the-money options, because if you take both Deltas, they equal 100%, so if you are long the call, that is 50%; if you are short the put, that is 50%.
It will replicate the stock penny for penny; you will make as much being long this particular stock replacement via options as you would owning Apple stock itself.
So this is a little more sophisticated than actually just buying a call or buying a put. How much experience do I have to have in options to really make sure I am not doing this in too risky of a way?
It is not risky at all, but certainly understanding that you must add up the two Deltas to get 100% of the stock; it is a little bit of education, like anything else.
Options is more of a thinking game than just buying or selling stock. It takes a while to understand the movements of these at-the-money options, but once you get it, it's a brilliant, brilliant trade.
So the natural question then becomes if it is easy to replicate the movement of the stock, why would I ever buy the stock outright? Why not always do this with options?
I often wonder why people do, because for me, from an allocation point of view, I would much rather use the marketplace's money than use my own, especially when it doesn't cost me anything. So I believe that the people who aren't doing it, it is just because they don't understand the options market.