If you're bullish, buy stock or call options?
If you're bullish, buy stock or call options?
Loading saved threads...
user10763 · External communityPost link
External question — Personal Finance Stack Exchange
Author: user10763
Original post: https://money.stackexchange.com/questions/121056
License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/
Adaptation: HTML converted to plain text; contact email addresses removed.
Presuppose that you believe a stock to rise in price. What are the pros and cons of buying a stock vs call option?
Aristofanis Papadatos
disadvises buying calls:
When investors purchase call options instead of buying shares of their desired stock, they essentially choose to highly leverage their returns. However, they should realize that there is no free meal in the market and, in fact, leverage is a two-edged sword. While it greatly increases the profits in the positive scenario, it also multiplies the losses in the adverse scenario. For instance, when investors buy an at-the-money call option and the underlying stock falls or remains flat, all the invested capital is lost, i.e., the trade results in a 100% loss. On the contrary, when investors purchase a stock and the stock falls, the losses are limited while they are also mitigated by the dividend payments. The contradiction between shares and call options becomes even more pronounced if an investor buys out-of-the-money calls. In that case, all the invested capital is lost even if the stock rises up to the strike price of the call on its expiration date. Consequently, investors should realize that call options have an entirely different risk/reward profile from stocks.
Even if the call option does not expire worthless on its expiration date, it is still hard to make a profit from it. Most investors underestimate the impact of the time decay of options on their returns but they should not ignore this critical factor. More precisely, buyers of call options suffer from the erosion of the time value of their options. Every day that passes by, the time value of options decreases. Therefore, in every boring session, buyers of call options lose money while, of course, they also lose money in all the negative trading sessions. Consequently, to make a profit, buyers of calls need the underlying stock to rally really fast from the moment they initiate their position.
Therefore, great timing is required for this strategy to prove successful. Unfortunately, experience has proved that the market is so unpredictable in the short run that no-one can consistently time the market. Even Warren Buffett and Peter Lynch have repeatedly admitted that they cannot time the market.
Yet
Philip Davies
counters him:
Sadly, you don't comprehend the strategy because we're SELLING much more premium than we're buying - that's why these trades work so well.
Reddit
weighs the pros and cons, but I see nothing conclusive.
Quote
Report
Bob Baerker · External communityPost link
External answer — Personal Finance Stack Exchange
Author: Bob Baerker
Original post: https://money.stackexchange.com/a/121058
License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/
Adaptation: HTML converted to plain text; contact email addresses removed.
Presuppose that you believe a stock to rise in price. What are the pros and cons of buying a stock vs call option?
Your question asks for a one size fits all answer and there is no such thing. For example, OTM calls have have a higher risk of loss but they offer leverage in return. OTOH, a high delta ITM call LEAP where the IV is reasonable almost approaches the return of owning the underlying but carries less downside risk. So the answer depends on whether you're approaching this in a more conservative investor-like fashion or as speculative trader.
Aristofanis Papadatos disadvises buying calls/Yet Philip Davies counters him
The problem with this juxtaposition is that Papadatos expounded on buying calls and Davies (full link text not available) is talking about selling premium. That's an apples and oranges and is a pointless comparison since they are strategies with very different outcomes.
The problem with your Papadaos quote is that he's citing the likely failure of buying leveraged speculative OTM calls as proof that buying calls will be a failure. As offered above, high delta ITM LEAPs offer a very different R/R spectrum.
I also take issue with his premise that:
For instance, when investors buy an at-the-money call option and the underlying stock falls or remains flat, all the invested capital is lost, i.e., the trade results in a 100% loss. On the contrary, when investors purchase a stock and the stock falls, the losses are limited while they are also mitigated by the dividend payments.
Suppose XYZ is $100. If you buy an at-the-money call for 2 points and the stock drops 10 points (see last week), would you rather lose 100% of $200 or lose 10 points?
Dividends lower cost basis but losses are not mitigated by dividends because dividends cause share price loss. IOW, it's a neutral effect, ignoring tax inefficiency.
The points that Papadatos makes are coorect but they are applicable for specific situations not all situations
Quote
Report
Post Reply
Quoted from Forex.com.bd-Editorial External question — Personal Finance Stack Exchange Author: user10763 Source score (net votes, not local likes): -3 Original post: https://money.stackexchange.com/questions/121056 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. Presuppose that you believe a stock to rise in price. What are the pros and cons of buying a stock vs call option? Aristofanis Papadatos disadvises buying calls: When investors purchase call options instead of buying shares of their desired stock, they essentially choose to highly leverage their returns. However, they should realize that there is no free meal in the market and, in fact, leverage is a two-edged sword. While it greatly increases the profits in the positive scenario, it also multiplies the losses in the adverse scenario. For instance, when investors buy an at-the-money call option and the underlying stock falls or remains flat, all the invested capital is lost, i.e., the trade results in a 100% loss. On the contrary, when investors purchase a stock and the stock falls, the losses are limited while they are also mitigated by the dividend payments. The contradiction between shares and call options becomes even more pronounced if an investor buys out-of-the-money calls. In that case, all the invested capital is lost even if the stock rises up to the strike price of the call on its expiration date. Consequently, investors should realize that call options have an entirely different risk/reward profile from stocks. Even if the call option does not expire worthless on its expiration date, it is still hard to make a profit from it. Most investors underestimate the impact of the time decay of options on their returns but they should not ignore this critical factor. More precisely, buyers of call options suffer from the erosion of the time value of their options. Every day that passes by, the time value of options decreases. Therefore, in every boring session, buyers of call options lose money while, of course, they also lose money in all the negative trading sessions. Consequently, to make a profit, buyers of calls need the underlying stock to rally really fast from the moment they initiate their position. Therefore, great timing is required for this strategy to prove successful. Unfortunately, experience has proved that the market is so unpredictable in the short run that no-one can consistently time the market. Even Warren Buffett and Peter Lynch have repeatedly admitted that they cannot time the market. Yet Philip Davies counters him: Sadly, you don't comprehend the strategy because we're SELLING much more premium than we're buying - that's why these trades work so well. Reddit weighs the pros and cons, but I see nothing conclusive.
Checking account access…