Buying Calls: Maximizing the Rosy View

Option buyers have to be optimists. They believe that a stock's price will move enough points within a limited time to produce a profit. If they are right, their return on investment is huge. If they are wrong, they are 100 percent wrong.

When you embark on a program of buying calls, you take the most speculative position that is possible with options. Since time works against you, substantial change in the underlying stock is required in order to produce a profit.

Remember, a call grants to the buyer the right to purchase 100 shares of the underlying stock, at an established striking price per shares, and before a firm expiration date in the near-term future. As the buyer, you acquire that right in exchange for paying a premium. You face three alternatives: First, you can sell the call before it expires; second, you can exercise the call and purchase 100 shares of the underlying stock; or third, you can allow the call to expire worthless.

As a call buyer, you are never obligated to buy 100 shares. In comparison, the seller must deliver 100 shares upon exercise of a call. As buyer, you have the right to determine which of the three outcomes will occur. The decision depends on:

• Price movement of the underlying stock and the resulting effect on the call's premium value.
• Your reasons for buying the call in the first place and how related strategies are affected through ownership of the call.
• Your risk posture and willingness to wait for future price movement of both stock and the call, as opposed to taking a profit or cutting a loss today. (This is where setting and following standards comes into play.)