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Options Strategy 1 - Purchasing Call Options with the 10000 Elephants Point and Figure Strategy
We will explain the basics regarding a stock option, but we will leave the detailed explanation of a stock option out of this article and will refer you to a few good free sources that can explain the details of an option as well as we can without wasting additional space or paper.
www.cboe.com - Chicago Board Options Exchange
www.investopedia.com – Investopedia
www.smartmoney.com – Smart Money
In general there are two types of stock options
Call Options – gives you the “option” to purchase a stock at an agreed price within an agreed time limit.
Put Options – gives you the “option” to sell a stock at an agreed price within an agreed time limit.
The stock option that we will be using in this strategy is called the “call option”
Call options are leverage in the stock market and give you the “option” to purchase a stock at a predetermined price within a pre-determined amount of time.
The fee that you pay to do this (called the premium) is non-refundable and is money spent whether the option expires worthless or expires in the money.
1 Call Option = the right to purchase 100 shares of a stock at a set value.
Example:
At the time of this writing
Microsoft is selling for $28.25
Microsoft’s January 20 Call Option is selling for $8.80
January – the month the option expires
20 – called the strike price and is the purchase price of the stock if you chose to exercise your option.
$8.80 - is the price for the option per share
In other words, purchasing this option for $8.80 X 100 shares = $880 gives you the right to purchase 100 shares of Microsoft at $20/share at any time up until its expiry date in October.
You can see by this example that if Microsoft went up in values before the option expires in January, the value of the option would go up in value and depending on much it goes up, the profits can be significant. If Microsoft climbed to $40, and you exercised the option, you would be purchasing 100 shares of Microsoft for $20 when they are worth $40 ($20 profit per share minus the cost for the option).
On the other hand, if Microsoft went down in value you could lose the price you paid for the option. In other words, if Microsoft fell below $20 there would be no reason for you to exercise the option to purchase it at $20.
The Strategy
In this strategy we will use
- Point and figure Charting
- Call option purchase
- Call option selling
You may have purchased our manual “Trading Strategy using Point and Figure Charts” available as a download at www.10000elephants.com to understand how we use Point and Figure Charting in this strategy and be able to recognize setups that we use to trigger this strategy. If you have not, please do so now. Unless you have a good understanding of Point and Figure Charting, you may not understand the basis of this options strategy explained in this article.
In our manual “Trading Strategy using Point and Figure Charts” we identify various setups that when recognized, trigger the purchase of the stock. We also cover risk management of your investment capital. You should not use this strategy until you understand the risks involved.
Using this options strategy, the setups in “A strategy using Point and Figure Charting” will not trigger the purchase the stock’s shares, but will trigger the purchase of an in the money option.
The advantage of using options over the purchase of shares is the ability to profit from stocks without paying the full amount for the stock.
Important Rule – never purchase more options during a trade than what you could afford if you purchased the stock alone.
For example – If you could only afford to purchase 300 shares of Microsoft, you would only purchase 3 Microsoft options in this strategy since 3 options gives you the option to purchase 300 Microsoft shares.
Which Options to Purchase
When looking at options available, you will notice that there are many options to choose from ranging in strike price and expiry date.
In this strategy, we are looking for a less expensive way to take advantage of the setups presented in “Trading Strategy using Point and Figure Charts” (available at www.10000elephants.com). We want the ability to purchase the stock, but at less cost than what we would normally pay. You can simulate the purchase of the stock by purchasing deep “in the money” options. By doing this, you are minimizing the premium paid on an option and making the use of the strategy less expensive.
At the time of this writing, Microsoft is selling for $28.25 per share.
A good “in the money” option to buy using our atrategy would be as follows:
January MSFT 20 Call is selling for $8.80 per option
When you purchase the option instead of the stock, you are paying less, but still getting the benefit of the potential profit if Microsoft rises above $28.25.
When to Purchase the Option
An option is purchased when one of the setups occur that are covered in “A strategy using Point and Figure Charting”. You can purchase this well received step by step manual on our website www.10000elephants.com .
Using the same strategy outlined in “A Strategy using Point and Figure Charting” you can substitute options in place of the purchase of the actual stock, and simulate the purchase of the stock making the strategy less expensive to use.
This is one of many strategies that are being presented by 10000 Elephants Trading Strategies ( www.10000elephants.com ).
Visit www.10000elephants.com to download more trading strategies.
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