Option Trading System – Buying Stock Call Option Strategies
Option Trading System – Buying Stock Call Option Strategies
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Strategy 5: Premium Buying A final strategy involves buying calls to average out the cost of stock held in the portfolio. This is an alternative to dollar cost averaging. Stockholders who desire to hold shares of a company’s stock for the long term may want to buy stock while prices are stable or falling, on the idea that lower prices represent an averaging-down of the overall net price per share.
However, the dollar cost averaging strategy, as effective as it is in a declining market situation, is not as desirable when stock prices rise. In that case, hindsight shows that you would have been better off to buy more shares at the original price.
This is a dilemma. If you plan to keep a stock as an investment over the long term, but you do not want to put all of your capital into the stock right now (fearing possible decline in value), one alternative is call premium buying.
When you purchase a call using this strategy, you seek longer-term out-of-the-money calls for relatively low premium levels. Then, if the stock’s value does rise, you can purchase additional shares below market value.
Example: Climbing the Wall of Worry: You own 400 shares of a particular company and you want to buy another 200 to 400 shares in coming months. You originally planned to buy more shares any time the stock’s price dropped, creating a lower average cost with each subsequent purchase. However, at the same time you are concerned about losing the opportunity to buy at today’s price in the event the stock’s price rises. You purchase two calls, one two points out of the money expiring in three months, the other seven points out expiring in six months.
By employing this strategy, you can have it both ways. If the stock’s market value falls, you buy additional shares and reduce your overall basis in stock; if the stock’s market value rises, you can exercise your calls and fix the stock purchase price at the call striking prices, even if the stock’s market value goes far above those levels.
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Buying more shares of a company whose prospects are increasingly poor is never sensible. However, in utilizing an options strategy such as premium buying in conjunction with downward dollar cost averaging, we assume that the investor has performed the required level of fundamental analysis to be confident in the company’s long-term value. This has to be offset against the cost of premium buying; you need to ensure that the money paid for call premium is not so excessive that the dollar cost averaging advantages are less than the advantages of simply buying stock at a higher price.
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