Buying call options is a good way to gain upside exposure to a hot growth stock. When the market is at a high, it’s a particularly good time to exercise such bullish options trades.
Growth stocks have exploded over the last decade, and even “old” technology companies like Amazon (AMZN) continue to be on an upward trend, although there has certainly been some recent volatility. So is this growth stock mania that will again create a bubble? Or are legit companies creating game-changing technologies, and is buying call options a good idea?
I recently bought my daughter an Amazon Echo. She wanted something that would allow her to play music in her room, and unfortunately, the tape decks and CDs from my youth are no longer a preferred sound system. However, I didn’t want to buy her an iPhone or iPad to stream music, as I didn’t want her watching YouTube videos or surfing the internet without adult supervision. Having used her Echo for just a few days, I could not be more impressed. And I’m a bit jealous I don’t have one.
For those not familiar with this new product, an Echo is a small wireless speaker and voice-powered personal assistant that is one of the first commercial applications of artificial intelligence.
What can it do? The better question is what can’t it do?!!
If I want the weather for the day, I simply say, “Alexa, what is the weather for today?” She will respond with a computerized detailed answer. Next, I might ask her to tell me a joke, or how many ounces equal one liter. Essentially, Alexa has the answer to all questions, and can also call you an Uber or order you a pizza. Some have called the Echo “Siri on Steroids.”
AMZN, the producer of the Echo, has done well in the stock market. At the current sky-high stock price, some people who subscribe to Cabot Options Trader and Cabot Options Trader Pro have reached out to me for bullish options trades to get upside exposure to AMZN. Those savvy readers understand the amazing power of options trading!
Using Options to Gain Exposure at a Much Lower Cost
A purchase of one call option contract is a bullish position that gives the buyer the right to buy 100 shares of the stock at a set price. For example, if a trader was bullish on fictional stock XYZ that was trading at 18, he could buy one of the 20 strike calls for $2. Because each call option represents 100 shares of the stock, a call purchased for $2 is actually $200.
If stock XYZ were to rally above 20, the trader could choose to exercise his right to buy the stock at 20. So if the XYZ stock price rises, the call’s profit would look almost identical to the stock’s profit. However, if the stock XYZ were to fall, the most the trader could lose is the $200 he paid for this call.
Knowing that buying call options would cost dramatically less than buying the stock, Cabot Options Traders were looking for ways to put on a bullish AMZN position. Instead of paying over $337,000 to buy 100 shares of AMZN, I might instead buy one AMZN February 3,400 Call for $199. The $199 call (as I’ve said) is actually $19,900, which is clearly significantly less than the $337,000 needed to buy 100 shares. If AMZN doesn’t move or falls, the most I could possibly lose on the position is the $19,900 I paid for the call.
However, if AMZN were to explode higher, my calls would jump in value. And at any point, I could decide to exercise my right to buy the stock, or simply sell my calls for a profit. (At Cabot Options Trader, we typically sell the calls out for the profit and not take delivery of the stock.)
Two Other Call-Buying Ideas
I could also use this call-buying strategy if I was afraid of buying the top in any hot growth stocks. For example, if I wanted bullish exposure to a stock on a meteoric run—instead of paying $10,000 to buy 100 shares, I could buy one March 95 Call for $18, putting just $1,800 at risk.
Or if I didn’t want to chase another booming growth stock, instead of paying $6,000 for 100 shares, I might buy one May 65 Call for $8, putting just $800 at risk.
Only time will tell if traders should be chasing some of these lesser-known technology stocks, and much of the stock’s performance will likely be tied to whether their groundbreaking technologies will become a part of our daily lives, like so many of Amazon’s services.
However, if you have some doubt, and don’t want to put a great deal of capital at risk, buying call options is a great way to get bullish exposure at a fraction of the cost of buying the stock.
Have you ever gotten into buying call options on high-priced stocks? How did it turn out? Leave a comment below.
*This post has been updated from an original version, published in 2016.