The Truth About Stock: It’s a Call Option with a Zero Strike Price

Originally posted at The Options Zone


When it comes to investments, most people have the idea that owning stock is a sound and prudent thing to do.  In fact, the Prudent Man Rule tells us that not investing a significant portion of one's assets in a diversified stock portfolio is imprudent.

Owning options is different.  Hardly anyone considers the strategy of buying options to be less than speculative.  To some, it's outright gambling.  In this discussion, I only mention call
options.  Why?  Traditional investors buy stock and probably never
consider selling them short.  Thus, a post relating to investing in
stocks must be from the stockholders perspective.  And that means owning
calls, not puts.

I don't like the idea of owning options as an investment, and never suggest that anyone invest that way.  The rationale behind my stance is that the vast majority of option buyers pay far too much in time premium, in effect placing a wager that the specific stock will move sharply higher soon, or before the option expires.  That is gambling and not investing.  A stockholder can afford to wait for his/her reason for buying the stock to be recognized by the market.  The individual investor who buys options cannot afford to wait as time erodes the value of those options.

For the small minority who have proven skills as a market timer, owning at-the-money or out-of-the-money options may prove profitable.  But buying those options is a trap for the average individual investor.

On the other hand, if a trader buys call options that are already in the money by several points, the picture is entirely different. These options have a high delta (75-85) and increase in value at a pace that almost matches that of the stock.  Obviously owning calls is less profitable when the hoped-for rally occurs. However the profit from that rally is 'good enough' when you consider that there is a big benefit that comes with owning these options.

In return for paying time premium, the call buyer gains a big advantage.  Specifically, loss is limited to the price of the call.  In a market downturn, instead of being exposed to a large loss (example, a $42 stock declining to $25), the owner of the call with a $35 strike price can lose no more than the option premium.  That amount varies depending on the stock's volatility and the remaining lifetime in the option, but it's likely to be in the $1 to $2 range, plus intrinsic value).

It's a trade-off that is not suitable for every investor.  But if you are willing to sacrifice a little upside potential in return for additional protection in a down market, these calls are suitable investments.  See a recent post on stock replacement.

If you heard of the strategy referred to as buying 'protective puts,' this is an identical approach.  Buying one put per 100 shares of stock is a method that is equivalent to owning the call option – with the same strike and expiration date.  When you consider trading costs, it's more efficient to buy calls than to buy stock and puts.

I am not trying to convince investors with long-term investment objectives to switch from stock to options.  My purpose is to compare stock with options and be certain that you recognize what you get when buying stock. 

Let's consider that $42 stock mentioned above.  It pays no dividend.  The table indicates the value of a 6-month call option, assuming the options trade with an implied volatility of 35.


Buyers of the 6-month 35 call option pay $148 per contract in time premium. Investors who hate paying anything for time premium may prefer the 6-month 25 call, which carries a time premium of only $29.  By buying this call with a lower strike price, you accept an additional downside risk of $1,000 per option.

For investors who insist on paying zero extra premium, and who are willing to take even more downside risk (but it's a small risk.  There is little likelihood that this stock can move below $25 – but it is possible) there's the 6-month call option with a strike price equal to zero.  Such options don't trade on any of the option exchanges, but they do trade on the New York Stock Exchange.  These options with a strike price of zero come with a bonus.  They never expire. They are called stock.

The point of this exercise is to illustrate that buying ITM options is not so different from buying stock.  I've seen brand new investors buy low-priced stocks for the simple reason that they cannot afford to buy higher priced stocks.  That's a big mistake.  It's much better to buy a few shares of a stock you truly want to own than being forced to choose from the universe of low-priced stocks.  That trader ought to understand that buying ITM $8 call options on quality stocks is better than buying $8 stocks.

A recent discussion with a reader prompted this post.  He is willing to invest cash in a stock position, but considers his option purchases to be speculative and uses far less cash when buying options.  That makes sense – from his perspective.  Without so-stating, it's clear: this trader buys low-priced ATM or OTM options.  The thought of owning deep ITM options instead of stock was not considered.  This post is dedicated to him and other stock owning investors.  Please keep in mind that call owners do not collect dividends and this discussion is targeted to non-dividend paying stocks.


The two Mark's disagree over the idea of 'playing with house money" in the     Pro & Con column.

Tyler Craig contributes a guest column and offers his take on the popular strategy of writing covered calls.


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14 Responses to The Truth About Stock: It’s a Call Option with a Zero Strike Price

  1. Michael James 05/14/2010 at 11:16 AM #

    Thinking of stock as options with a strike price of zero is clever — I’d never thought of it this way before. So, options become a kind of generalization of stock ownership. It’s one of those things that is obvious once pointed out, but you never think of it yourself.

  2. Mark Wolfinger 05/14/2010 at 11:54 AM #

    Hi Michael,
    It’s just a different perspective.
    And the owner of these options gets to collect dividends.

  3. Larry 05/15/2010 at 4:00 PM #

    Mark, I’m intrigued by the concept of buying calls in lieu of buying stock. If buying calls that are ITM are the way to go would it also stand to reason that longer term options would go with that strategy. I’m even thinking of the LEAPS which can provide expirations over a year from now. Granted, I would be paying for more time premium but it provides almost the same investment horizon I consider when buying stock. (And selling calls against that stock)
    I’m not going to run out and start buying a ton of calls but I would like to continue to learn about this and other investment strategies. (Actually investing a small amount and watching the changes over time is the best way for me learn. It motivates me to stay engaged versus a hypothetical trade.)

  4. Mark Wolfinger 05/15/2010 at 6:12 PM #

    There are three major points when buying ITM calls instead of stock
    1) You pay time premium. That gets you the wonderful benefit a limited downside loss. I return, you sacrifice every penny of that time premium if you hold through expiration.
    2) This is equivalent to buying stock and buying puts. You don’t get the dividends, but you are compensated for that in the price of the options.
    3) This is key. The plan under discussion is a stock substitute. DO NOT get tempted to save money and buy less expensive, and lower delta calls.
    When you do that you become a speculator. You become the gambler who buys ATM r OTM options looking for a large increase in the stock price.
    I strongly discourage gambling with options, so to me – the recommended strategy is buying a high delta, low time premium call. If LEAPS work for you, that’s ok. But you do not want a 65 or 70 delta call option. In my opinion that’s sacrificing far too much upside potential, AND the time premium can be so high that it does not afford enough downside protection.
    You plan is viable, but plan carefully.

  5. Josh 05/16/2010 at 7:07 AM #

    Hi Mark,
    How do you feel about synthetic longs? Such as a stock that’s at 35 and one would buy the 40 call and sell the 30 put with the idea that the stock is already undervalued and would be a better value for the money at 30… Of course I’m hoping the stock rallies and I can sell the call and buy back the put.
    I’m guessing there’s maybe a big greek risk I’m not considering. Is there? Would buying one or two less calls to finance the purchase of some cheap units be an improvement?

  6. Mark Wolfinger 05/16/2010 at 9:28 AM #

    Unless the strike and expiration are IDENTICAL, it is not a synthetic long. Your play is a risk reversal, and is very (very, very) different.
    Your sample trade does NOT mimic the performance of the underlying stock.
    This is exactly the reason I hesitated to write about stock substitutes in the first place. You cannot buy OTM calls and expect to make money over the long term. Sure you hit the occasional jackpot, but that is strictly gambling.
    Owning ‘units’ is good insurance against a catastrophe; it’s a gamble on a market melt-up or meltdown, but it is not stock. It is not synthetic stock. It’s just a long delta position.
    It has nothing to do with wanting to invest in the stock, with protection.

  7. Josh 05/16/2010 at 10:46 PM #

    Understood, thank you.
    How about this… I often read about selling credit spreads whether call or put spreads (or ICs) but I’m curious in what situations would the following trade work? (besides the obvious, if the index price changes in our favor)
    Index is at 1000…
    Sell 950 call, Buy 1000 call (if bearish)
    Buy 1000 put, Sell 1050 put (if bullish)
    Thanks Mark,

  8. Mark Wolfinger 05/17/2010 at 8:46 AM #

    These trades are bearish and bullish respectively. I can see no other reason for making these trades, except to play market direction.
    If the market moves again you – even by a small amount, you fave the chance of maximum loss when both options finish ITM.
    You have two major choices for credit spreads:
    a) Market direction – in which case one tends to trade options that are close to the money
    b) “income generating” or positive time decay plays. In those you want OTM options and hope they stay that way.
    To me your play is directional and I can see no other reason to make this trade.

  9. Josh 05/17/2010 at 8:42 PM #

    Aren’t those credit spreads deep ITM? Short 950 call (ITM), long 1000 call(ATM), index at 1000… if the market moves higher, doesn’t the maximum loss depend only on the the difference in extrinsic value between the two calls. On the one hand, I understand these are directional bets and I get that there’s no free lunch. But what if I plan on taking profits if the market declines, and letting it expire (and face exercise) if it doesn’t?
    (Unless a better use of capital appears relative to the cost of exiting the credit spread)
    Let’s say the market rallies and is at 1050 on expiration. Wouldn’t the 50 per contract gains on my long calls plus the 50 I still have from the spread sale equal the 100 loss from the short calls? I know there’s something I’m missing because it obviously can’t be that easy… is there a greek that explains all this?
    [If it isn’t obvious by now, I’ve never traded options, and plan on keeping it that way until I thoroughly understand them…]
    Thanks again, Mark.

  10. Mark Wolfinger 05/17/2010 at 10:43 PM #

    1) No. It was not at all obvious that you have never traded an option.
    2) I thought you were a beginner, in over his head, and asking questions to better understand what has been happening.
    3) In my efforts to help that person who was trading without sufficient education, I spent many hours in an effort to help you see the light.
    4) To learn that your questions and points of view come from someone who has not traded is startling. And to be honest infuriating.
    5) Here’s what I believe
    a) It was your duty to tell me the questions came from someone who never traded an option
    b) It’s not right to take my time to explain one tidbit after another when you are not experienced enough to make much use of the information.
    c) If you want to ask questions, they should not be out of the blue, but based on something concrete.
    For example, your expectation (above) to sell the 950/1000 call spread and collect $50 is beyond absurd. It clearly demonstrates zero understanding of options. Ask yourself: Who would pay $50 for that spread. What could that person gain by making that trade?
    You have not even bothered to look at an index and price the spread with one option ATM and the other 50 points ITM. You will discover that this spread trades for just a teensy bit less than $50.
    6) Yes, something is missing. Your job is to go out and learn something about options. You can do that with The Rookie’s Guide of by taking webinars or by continuing to read what you can.
    I’m pleased that you want to have a good understanding of options before trading them. That’s intelligent. But you need some structure. You need a plan.
    You should be asking questions to fill in a hole – when something isn’t clear to you. When you ask a question out of idle curiosity – and when the answer has no value to you – think about the time I, or anyone else, put into taking the time to reply. I am very disappointed.

  11. Josh 05/18/2010 at 12:52 AM #

    That’s a very strong opinion to hold… my duty? How am I to know that you thought I was asking for advice with trades I’m actually making… I’ve never used phrases like “I sold an IC…”, it’s always “what if I were to do”, etc…
    Thinking that I am currently trading options was an assumption on your part, and expecting me or others to know that your advice is only for those currently trading options, when the whole focus of your blog is on educating “Rookies” is pretty unreasonable. I’m not a mind reader… I don’t know where you draw your (arbitrary) lines in the sand.
    So I asked a question that shows my inexperience (and that I hadn’t thought it through). Big Deal! If you don’t want people to ask you questions, don’t make yourself so available, and don’t name your blog “Options For Rookies”!
    Also, I may be new to options, but I’m not new to trading. I’m not asking questions just to satisfy my random musings. I design automated trading systems for futures and stocks and while I’m not currently trading options, knowing what is and isn’t realistic helps me decide what strategies to pursue and spend resources on.
    Look, it was an off the cuff question… does it really need a sermon? I’m sorry you feel you’ve wasted your time. I feel like I learned something. If you go back and look at my other questions, while they would still reflect those of a beginner, they are more thought out.
    I’m disappointed as well… don’t worry, I won’t ask you another question.

  12. Mark Wolfinger 05/18/2010 at 8:31 AM #

    5a) ‘Duty’ is too strong of a word. I was trying to explain that I put a great many hours into this blog, with nothing to show for it except for the appreciation of readers. There’s very little financial reward; very few people click on ads, the blog doesn’t sell many books. This is a labor of love.
    I draw no lines in the sand. I reply to many questions from people who understand little or nothing. For example: “I bought an option and paid $2, am I allowed to sell it at at $0.50?” The experience of the questioner is obvious.
    But I thought we were having a realistic discussion that was beyond theoretical. Those questions require answers with more detail.
    Look at it from my end – anyone can make up dozens of scenarios and them imagine all sorts of conditions. That person understandably wants to know ‘what if.’ But is it really fair to ask questions that involve random thoughts on a random topic?
    When there is something a reader does not understand, I’m happy to clarify. But this blog is not meant to be a complete instruction manual on how to trade options. It represents pieces of advice, my thought on topics of interest to me and that I hope are of interest to readers.
    You may not be interested in the details of risk management, but there is no one else – anywhere – who offers as much as I do in trying to explain why it’s important and how to learn to become more skilled at managing risk. Where else can you find a series on risk management with such detail> Nowhere. I may lose readers who find the topic uninteresting, but I’m helping any reader who needs instruction in this area. I produce a very valuable body of work and it takes lots of time, as as I said, the only thing I get in return is words of thanks.
    This blog is a valuable resource. But, obviously not for everyone. Please note that I reply to EVERY question. I do not pick and choose. All I ask in return is that the question have some importance to the questioner.
    An off the cuff question that takes more than a half hour of my time is hardly fair. Sure, I could reply in 5 minutes, but that would not provide a good answer for the questioner. And isn’t seeking a quality response the reason you ask a question? I don’t supply the one or two sentence answers that other bloggers do.
    But when the scenarios are 100% unrealistic – such as selling that spread for $50 – what is to be gained by asking me to spend time composing a reply that delves into an explanation of why the scenario is unrealistic?
    With 15 seconds of work on your part, you could have seen that the spread doesn’t trade near $50. Is it too much to ask that you, as a trader, understand that selling a spread for it’s maximum value is a strategy that can never lose – it’s a guaranteed cash machine, and thus, is unrealistic?
    There is no requirement that you have trading experience to pose questions, but can’t you see that the answer would be different?
    5b) Sorry to hear that.

  13. Josh 05/18/2010 at 3:58 PM #

    I admit that question was a total brainfart… I have priced spreads before… this is the kind of mistake one makes when tired. For some reason basic concepts didn’t make sense for a while.
    I have no desire to argue with you. I read your blog because I find it interesting and I respect your perspective. If I have any questions or comments in the future, I’ll do some homework first.

  14. Mark Wolfinger 05/18/2010 at 11:52 PM #

    Thanks. I always appreciate a good conversation or question.
    Best regards,