I Don’t Usually Trade Long Options…But When I Do

Who buys calls?  Who buys puts?  I often wonder this, as I am usually the one selling them to others.  Do buyers really think they’re going to profit from them?  Is a real person buying them?  Is it a bank, or a “market maker” (they are people, right?  I admit I’m confused about those mythical creatures.)

Anyway, it’s a rare happenstance that I think a call or put is worth buying.  One thing that makes an option attractive to me is its structure of being deep in the money.  That way, unless the stock moves opposite the direction I’m thinking it will, I’m mostly just paying for what has already happened.  It’s a little like buying stock.  I’m paying for the intrinsic value, and what could be more fair than that? (Beyond just buying stock, of course.)  Anything above the intrinsic is a risk I’m taking (actually, the intrinsic is a risk, too, and it’s more of a risk than simply buying stock, which is also a risk, but we’re talking about gradations of risk, here.)  So, here is what I did and why I did it:

I had 200 shares of SVXY.  Actually I had many more, and still have them, but I selected 200 prime cuts of fine flank SVXY and wrapped it up for sale.  $9,250.77 later, I went shopping in the aisles of the supermarket called “Options Chains” and rang up some expensive purchases.  At first I got into October but later traded out; those details aren’t important to this story (no, wait!  Details are important as I made a small profit doing that).  The profit was negligible in the grand scheme of things, so let me get to the conclusion of this story.

Of course, the story is not over and will not be until as late as December.  Here’s what has happened so far, though:

I replaced 200 shares’ worth of SVXY (trading at $46.29 on the day I liquidated them) with 7 calls for SVXY $40 strike at the December 18th expiration, paying $12.30 for each option.  That’s $8,610 worth of betting that SVXY will be at least $52.10 by expiration.  This assumes that if SVXY is trading at $52 on the day of expiration, $40 calls would be worth $12.00, or about what I paid.

In the meantime, though, SVXY is not approaching $52; it’s still about $47 as of this writing (remember, it was about dollar lower when I “converted” shares to calls), and right now the calls are fetching about $13.00.  I could sell right now and get a few dollars in profit.

My hope, however, is that hanging onto the calls will allow me to benefit from the rise in share price more than I would have, had I simply held onto the 200 shares.  Example scenario:  Near expiration, SVXY may trade at something like (this is a hypothetical number) $62.  This is a full ten dollars over the price needed for me to break even on my calls.  In this example, the $40 calls would be trading for $22 each.  Remember, I only paid about $12 each for them.  Let’s compare my benefit on the calls vs. simply holding the stock, with no calls bought:

Calls bought in September for $12.30 each, 7 of them:  Purchase price $8,610.  Sale price near expiration:  $15,400, which represents a gain of $6,790.

Shares held from September (at the price and date I executed this little plan) through the date the calls I would not have bought would expire:  200 times $46.29 = $9,250.77 and the fantasy price quoted above on expiration date of $62 times 200 = $12,400 which represents a gain of $3,149.23.  You can see that the calls would net about twice as much profit as just the shares would.

Note that I did not use all of the cash generated from the sale of shares to purchase calls; I still had some left over, but I did not include that in the comparison.

What I’ve basically done is attempted to use the gain I had previously hoped to get from my former lot of 200 shares of stock and increase the profit, above a certain price point in SVXY, to the gain I’d get from having 500 additional shares of stock (700 total)  instead of just 200, with some premium paid for the privilege, of course.  At a share price of about $54.70, I’d start to make more from the options versus just holding the shares and saving myself the stress and risk.  Of course I’m hoping for an all-out party in which the calculations break the calculator.  But before that happens, let’s just hope I’m not holding a pile of public-restroom paper towels for which I paid enough money that I could have bought a serviceable used car instead.