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Strategies & Market Trends : Three Amigos Stock Thread

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To: Sal D who wrote (7776)	8/16/1998 6:28:00 PM
From: Sal D	Read Replies (3) of 29382

Thread, as I stated earlier I would be posting more on options as a way to perhaps learn more about them and also to bring to light some of there uses for the people who may not know how they could work for them. Options are risky (but what isn't) and may not be right for everyone, as always be careful and do your research. I will start with the purchase of call options. There are many reasons an investor might purchase a call option, short term or speculation are perhaps the most common, but there are other investment oriented reasons. As with all option strategies there are different trade offs. The strategy with the lowest purchase price has the highest risk, and the highest purchase price has the lowest risk. Call options example #1: Mike has his eye on a stock (we will call it ABC trading at $25.00 per share) for a long term investment. He is also concerned about the upcoming earnings report but still feels this is the time to buy. Because of his concern about the upcoming earnings report he would like to limit his risk. Mike believes the stock could move up or down $5 as a result of the report, so Mike has a $5 risk- reward profile. Lets say Mike has $2,650 to invest and the $25 call is trading for $150 ($1.50 per share). As we said earlier Mike believes the stock could go up or down $5 during the life of the option. The $25 call offers a different risk -reward profile then just buying the stock. Mike believes his profit potential is $3.50 per share if the stock rises $5. The call offers a different method of adding the stock to his portfolio. Mike can buy the call for $150 and deposit the $2,500 in an interest bearing account. If ABC is above $25 on the expiration date Mike can purchase the stock by exercising the call and using the money in the interest bearing account. ABC would have been purchased for $26.50. If ABC is $30 Mike would have a $3.50 per share profit. If ABC had a bad earnings report and is trading below $25 at expiration he can let the option expire. Mike's maximum risk was the $1.50 per share he paid for the call minus any interest he received off the interest bearing account. The call option enabled a long term investor to purchase a stock and limit the risk during the initial holding period. The trade offs: The negative was a higher purchase price and the positive was limited risk. Joe

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