Owning Stock vs Owning Calls

Hi Mark,

I think you taught me a lesson on not to get fixated on cost
basis. I have to tell you that cost basis is the thing I am obsessed
with since day one of investing and still is at the moment. It would
take a long way to move away from it but I’ll take your advice to focus
more on risk/reward.

However, I disagree with you on one thing, which is when you compared
the risk of holding stock vs long calls/call spreads. It is obvious
that I can easily lose 100% of my call/call spreads. It is also possible
to lose 100% if I’m long stock, but the possibility is very remote. In
terms of absolute dollars, the amount I can lose in a short period of
time is going to be a little more than the maximum loss in options, but
it is very unlikely that I’m going to lose all my money in DFS.

Long calls to me is a short-term speculative play and long stock is
for a longer term, and I am comfortable with my stock positions not
hedged. The amount I allocate for stocks is a lot more than I allocate
to options (since I’m still a relative rookie in options). The amount of
money I am willing to commit to one option position can only buy
some very OTM calls (which normally don’t end up ITM) but can buy
spreads that are more profitable. That should explain why I’m
comfortable with long stock but not the long calls.



Hi F,

1) It's my opinion that being obsessed with P/L is non-productive.  I cannot provide evidence that it's true.  The final choice depends on how you decide to manage your portfolio.  From my perspective, I own a position as it exists right now:  Do I want to hold it, sell it, add to it?  That's the decision.  Why should my original cost play any role in that decision?

2) I NEVER recommend owning long calls as a directional play.  I did suggest owning high delta calls as a stock replacement for investors who want to reduce downside risk.

I NEVER will recommend owning OTM calls for anything except protection – and I really don't like owning OTM options for any reason. So, if you took anything I said as a recommendation to buy such calls instead of stock, there was mis-communication.

NOTE:  This conversation refers to owning single options as a directional play.  [The kite spread uses OTM options, and that play is not relevant to this discussion]

3) If you feel comfortable owning stock, then by all means, own stock.  The idea of substituting high delta call options apparently does not appeal to you. 

It's good that you disagree.  Blindly agreeing with someone else is a bad idea.  Don't abandon your methods unless you are sure you are doing what is right for you.

Nevertheless, DFS offers an ideal scenario for stock replacement.   DFS Jun 13 calls carry very little time premium (20 cents).  For that small premium plus the 2 cent dividend, you can own insurance.  If the stock drops by 5 points, that's a lot worse than losing $3 on a call option. 

However, If you consider that time premium to be too much to pay, then your decision is based on complete knowledge of your choices.  That's ideal.

4) This is never mentioned, but stock can be thought of as a call option with a strike price of zero, and an infinite expiration date.  You prefer to own this zero-strike call.  There is an alternative: the Jun 13 call (an 8-week option) has a time premium of ~ 20 cents. 

5) You consider calls to be a short-term speculative play.  That's because you think in terms of which calls you would buy to gamble.  Those calls are very speculative and you are right to commit only small amounts to such plays.

Consider this:  You are willing to commit cash to owning the zero strike call.  And you are willing to speculate with a small sum on an ATM or OTM call.  But, you ignore the possibility of owning a high delta call. 

I know it seems as if I am trying to confuse you and take away your cherished beliefs.  But I find this philosophical discussions fascinating.  Analyzing a position and turning it into something safer, at a reasonable cost, is always worth considering.

But if you can even think about – as you say you plan to do – looking at risk/reward for positions after you own them, then perhaps you can consider stock substitution – especially when the cost is so little.  I agree that it is a more painful decision when the time premium of a 2-month 80 delta call is several dollars (obviously on a much higher priced stock).

6) I recommend owning high delta (~80) call options under these conditions:

a) You want to own stock
b) You believe the stock is headed higher, but don't want to take much risk

Under those conditions, selling the shares and replacing them with high delta calls solves the problem.  Solid participation on the upside and limited losses.

FYI, this trade is exactly equivalent to buying a put option to protect a stock position.

d) I never recommend buying calls.  But if you are a directional player who buys stock, high delta calls are a very reasonable alternative.  I never recommend buying protective puts.  But if the conditions stated above obtain, then stock replacement is an equivalent choice.



Coming in the May, 2010 Issue of Expiring Monthly:

  • Interview with Dr. Brett Steenbarger – trading coach and psychologist
  • The CBOE Benchmark Indexes
  • Pro and Con: Trading with House Money

and much more


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8 Responses to Owning Stock vs Owning Calls

  1. JV 04/27/2010 at 1:16 PM #

    Looking for potential trade feedback.
    This market is confusing to me for my normal condor strategies. I sat out for April expire and kept waiting for some kind of directional jump but …
    Would rather not sit on sidelines again, but clock is ticking.
    I usually wait for a jump in one direction before placing the up or down spread. With this flat market Im thinking of putting on all 4 legs at once at a lower probability than usual.
    Looking at a 770/790/690/670 on the RUT. I had my first big loss in March and therefore a bit skittish now so looking for a little feedback before going in. Would this be a trade you might consider? Thank you sir.

  2. JV 04/27/2010 at 2:12 PM #

    Follow up question to above.
    With current low volatility could it be beneficial to implement a strategy other than iron condor that may be more positive vega?

  3. Mark Wolfinger 04/27/2010 at 2:25 PM #

    Hey JV,
    As I look at the option delta (RUT = 727), I see the 770 call has a 24 delta and the 60 put has a 27 delta.
    I would not consider this trade for two reasons. But, neither of these apply to you. My comfort zone prefers to begin with a lower delta for the options sold. I don’t like the idea of a 47% chance (20 + 27) that one of this options is going to be in the money when expiration arrives in June (I assume this is June; you neglected to mention).
    [You do write about the ticking clock, so perhaps you mean May options: The premium is near $4 and the deltas are 13 and 20]
    With that risk, there is also a very good chance (>90%) that RUT will move to touch either strike price prior to expiration. That’s not for me.
    But you must find your comfort zone. Thus, there is nothing fundamentally wrong with this trade. And this is true for any options you care to trade. There’s a different risk and reward for each possible trade, and truthfully, I have no idea which options suit you best.
    The primary risk consideration is size. Thus, if you have doubts, trade less size right now.
    I hope you recognize that trading 20-point IC is no different from trading two 10-point iron condors (My 2nd reason for avoiding your specific trade is that I prefer to enter with a 10-point spread). Thus your position is equivalent to trading these two iron condors (although you can break these up into different call/put spread pairs):
    770/780C; 670/680P and
    780/790C; 680/690P
    I find it unusual that you want to adopt a market strategy that is non-directional (i.e., profits when the market doesn’t move too much), yet you want to enter the trade with a directional bet – by doing one side before the other.
    If you truly have directional skills, why trade iron condors?

  4. Mark Wolfinger 04/27/2010 at 2:44 PM #

    Beneficial can only be know later. However, it is a prudent risk-reduction technique to trade any of the Greeks (in this example, that’s vega) closer to neutral. Iron condo traders are always short vega, and gamma, and have positive theta.
    You can always decide to trade vega negative (iron condors), vega positive (diagonal spreads or calendars), or a combination of trades to make the position vega neutral.
    This strategy is best reserved when you expect IV to increase, or when you fear being short vega.

  5. JV 04/27/2010 at 2:46 PM #

    Thanks … was looking at May. I have no directional skills which is why I prefer neutral trades. I just have seen that sometimes by waiting to place the put spreads on down days and call spreads on up days can potentially increase the profit zone a bit with desired premium. But this may be just a futile attempt.
    Also, wouldnt the 780C and 680P in your example cancel each other out on 2 10 point spreads?

  6. Mark Wolfinger 04/27/2010 at 2:56 PM #

    Yes, they ‘would’ cancel each other if you actually made those trades.
    Nevertheless, the position you would own is exactly the same as if you did do both of those spreads (and wasted commissions in the process). I just want you to be aware of the equivalency of the positions. I am not suggesting you make those 10-point IC trades.
    I agree that opening put spreads on a down day – with the IV probably increasing, is worthwhile. What I urge you to check is just how much more you can collect for the call spread if you are lucky enough to sell the puts prior to a rally. Remember that the price increase is accompanied by an IV decrease, so the true gain i the price of the call spread may be far too little to be worth the risk.
    When you do sell puts, look at the call spread price and watch it change if you get the rally. Feel free to report back to us.

  7. F 04/30/2010 at 11:17 PM #

    Hi Mark,
    I think I should list some numbers to better illustrate my situation.
    1. $1000/$2000 – my typical stock trade amounts (gives me reasonable commission %)
    2. $100-$200 – my typical options trade amount
    3. 5-20% – amount I try to capture from a spread
    Combining #2 and #3 gives me a max options trading loss in the ball park of #1 (stock).
    I do understand you were not encouraging the purchase of OTM calls, the reason I brought it up is because the amount I am willing to spend on a single option position, $100-$200 is only going to buy me those speculative calls. I did buy some speculative calls last year when I started, doubled my money on some and lost 100% on a few, which is OK – they’re small enough that I don’t mind losing them all in exchange for a valuable lesson. I stopped doing this since I got my level 3 approval to trade spreads instead of only trade single-leg call/puts (Now I think about it, why would someone learn to trade straight calls/puts before vertical spreads?).
    Your suggestion on high delta calls is much appreciated. I have overlooked these cheap calls and instead start building spread once I have the options chain data. I forgot one of the reasons that I started speculating using slightly OTM call spreads vs far OTM calls is to spend less money on time premiums. The time premiums in the Jun DFS 13/14 calls aren’t bad at all. I’ll definitely take a look.
    I, too, enjoy this exchange. I have already got a couple new options ideas that I would have never had thought about.

  8. Mark Wolfinger 05/01/2010 at 5:10 PM #

    You say you look to make 5 to 20% from a spread. Yet, this discussion began with your ownership of an 88 cent spread and trying to sell it @ approx $1.40. That is far above 20%.
    How can you make any money, after commissions, if you earn 5 or 10% from a spread? And if you do eke out a profit, is it a good investment, considering the risk of loss? Just asking.
    Nevertheless, I do like that you trade spreads, not naked longs.
    Why would anyone trade calls or puts and not spreads? First the people who decide the clearance level for options trading are clueless idiots who never consider risk. Second, most newbies have big egos, thinking that can turn $100 into several times that amount – on a consistent basis.
    Pleased to hear you have expanded your horizons. Good trading.