If you’ve been thinking about getting that third mortgage and buying wacky, out-of-the-money call options on the U.S., you’re not the only one. There has been a raft of bullish news lately.
The ISM Manufacturing number printed stronger than expected at 57.3. This is the strongest it has been since April 2011.
Jobless claims fell again for the sixth week out of seven.
The price of oil continues to drop as inventories rise well above historical averages.
According to Case-Schiller, home prices are up 13.30% this year.
And if that wasn’t enough, the Nasdaq has cracked the 4,000 barrier to the upside.
Bulls, Baby
At this point in a four-year bull run, you might be thinking the market is getting over-valued and it’s too late to dive in. You have every right to think “I’m not going to be a sucker this time” after two major stock market meltdowns within a decade – and a housing implosion to boot!
Here’s the thing: You don’t have to go all in to still make money from this bull market. You can keep 90% of your money in bonds or gold or under the mattress – wherever you feel is safe. Then you can take 10% and leverage up into options. This will put your money to work without risking all of it.
Here’s how to do it.
Options and You: Making Bank
Let’s say Dell is trading around $11, and you think it’s headed higher. You want to buy 100 shares, but that would cost $1,100 – and maybe you don’t want to spend that much upfront and tie up your capital. Maybe you can’t afford to pay it all now.
Here’s the options alternative…
Rather than pass on the trade, you can buy one call option on Dell in anticipation of its value rising in the future. This gives you the right to buy those 100 shares at your desired strike price at or before options expiration for a much lower cost.
For that right, you pay the option seller to “hold” the shares for you at that set price until expiration (in other words, the premium).
You just have to decide how high you think Dell shares will rise – and over what period of time – so you know which option to buy.
How To Buy
To execute an option buy, the official lingo is “buy to open.”
So having looked at Dell’s options chain, you decide to buy the $15 call, which expires in seven months.
To ensure that you get the best possible execution price for this trade (or any trade, for that matter), make sure you use a limit order when you “buy to open.” This is basically an instruction to the brokerage to only buy the asset at or under a specific price.
The best way to do it is to set the limit order price about halfway between the bid price (the price at which a buyer is willing to pay) and ask price (the price at which a seller is willing to sell) on the options chain.
Remember that the current price of an asset only reflects the last trade, whereas the bid and ask prices are more accurate representations of the prices you can buy and sell for. So rather than pay the “market price,” the better play is to use limit orders. Once the price hits your limit price, the trade will be executed.
So for example, if the bid price for the $15 call option is $0.45 per contract and the ask price is $0.55, you’d instruct your brokerage to: “Buy to open the Dell November 2009 $15 call with a limit order of $0.50.” Or better yet, type it into the form using an online broker like E-Trade.
In our Dell example, given that the contract comprises 100 shares, your outlay for the $15 call would be $50 ($0.50 x 100 = $50). As you can see, that’s significantly less than the $1,100 you’d shell out for buying the 100 shares outright.
So with $15 as your strike price, you now have the right to buy those 100 Dell shares for $15 a piece any time before the expiration date on the third Friday of November. Ideally, you want the shares to be higher than $15 by expiration, thus enabling you to either buy them for less than the current market price or make a very good profit on your call option.
This is the beauty of buying call options – you greatly increase your leverage. To control the same number of shares (100), you have just $50 at risk versus $1,100. You’ll also emerge with a greater profit, as option prices move more dramatically than the underlying asset.
The danger here is that if Dell’s share price doesn’t move higher and you don’t sell in time, the option will expire worthless, and you’ll lose the money you paid for it. But then again, your 50 bucks could turn into $100 in a matter of days.
If you like to make money fast and can stomach the volatility, options trading is for you.
Christian DeHaemer
Check us out on YouTube!Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
