Be Careful Speculating With Call Options

At Steadydime, the majority of the time, we are sellers of options. We like to capture the volatility risk premium and, in turn, collect that premium. Although when we have too much time on my hands, we tend to get restless. Sometimes that restlessness leads to exciting decisions such as new work-related paths or spontaneous travel. However, free time can sometimes trigger something that isn’t always healthy, namely impulsiveness. It’s funny to hear stories of people buying random stuff on Amazon during a bout of boredom. It’s not so amusing to hear about traders and investors making downright stupid moves because time trumped rational thinking.

In our modern environment, there’s added danger if you pay attention to the stock market, particularly equity options. There’s the too much time factor. On top of that, there’s considerable volatility in the market. Factor in several handfuls of biotech companies racing to bring a Coronavirus vaccine or therapeutics to market, and you have a recipe for disaster. Granted, this can also be a recipe for making a ton of money. However, I have seen this confluence of factors turn south one too many times.

Let’s consider a half hypothetical, half real-life example because, at the moment, we don’t know how things will turn out.

Trying To Hit A Homerun With Options

Consider Inovio Pharmaceuticals (INO). The stock has been on a wild ride. As of May 1, 2020, INO has ranged from a 52-week low of $1.92 to a 52-week high of $19.36. As of the market close on May 1, 2020, the stock cooled off a bit, settling at $10.28. It was down roughly 14.5% on that day alone. In fact, over the course of the last week in April, INO dropped from a high of

$16.50 to the aforementioned $10.28 close.

Options often tempt traders and investors because they require less money to make a buy or sell move on a stock. For example, if you’re bullish on INO and want to buy 100 shares, you would need to put up roughly $1,028. If you don’t have a thousand bucks to easily spare, you probably shouldn’t be considering this trade, to begin with. But, that aside, it can be psychologically attractive to purchase, say, the INO June 19, 2020, $11 call option for $2.75 ($275) with the intent to trade it as the stock (hopefully) moves up. Heck, you can have control over 400 shares for about the same amount of buying power it takes to own outright 100 shares of the underlying common stock.

At the most basic level of caution alongside this strategy, you have to be mindful of the impact of time decay on an option contract. But it’s not merely the real and objective concept of time decay that you have to worry about. It’s the notion of your intent.

Do you believe in the company so much so that you want to participate in as much of its anticipated upside as humanly possible, OR are you more attracted to the notion of making a quick buck?

If it’s the latter, you’re in the dangerous psycho-emotional territory. Crowds (in the theoretical sense and with absolutely no pun intended) develop around these types of stocks (biotech always provides the best, most classic examples) and can fuel irrational emotion that prompts investors to trade irresponsibly or turns otherwise competent traders into speculators swinging for the fences with no real action plan in place. Don’t let yourself fall into either one of these categories.

Put another way; you’re better off investing in call options of a tried and true blue-chip (The Clorox Company comes to mind during this pandemic) with a long time to expiration than you are taking a flyer on a company with a sliver of hope to change the current messed-up world as we know it.

LEAP Of Faith

As an addendum, you might be looking at a stock more traditionally fit for long-term investment amid the Coronavirus uncertainty, a stock such as Gilead Sciences (GILD). It closed at $79.95 on Friday, May 1, 2020. Here again, shelling out $8,000 for 100 shares doesn’t sound as enticing to some as buying a handful of call options for a fraction of the cost.

You might be tempted to make a longer-term option play with GILD with the hope it will come up with a Coronavirus breakthrough. This might put long-dated call options or LEAP (Long-Term Equity Anticipation) options on your radar. With a LEAP, particularly one that’s out of the money, you put a relatively small amount of cash (or buying power) with the potential for outsized returns if the underlying stock increases in price.

Consider the GILD January 21, 2022, $100 call option for $9.55 ($955). For under $1,000, you have control over 100 shares of GILD. But, more often than not, you’ll use your call option as a trading vehicle. If GILD continues on the upward trend, it has been on this, and over the last year, you’re probably going to be in good shape, making this bet. That said, you absolutely must pay attention.

Whenever I buy this type of call option, I set both price and sell date targets. First, I set a modest percentage gain target. If I hit it, I sell at least half of my position, if not the entire thing. Second, I set a date I will sell all of my contracts on, no matter what is going on. With LEAPs, it can be tempting to let it ride a little bit longer, but the closer you get to expiration, the more time decay can play tricks you didn’t see coming. Unless you’re an expert in how time decay functions (and few of us genuinely are), it’s best to stay true to price and sell date targets to avoid unnecessary stress.

Bottom line — this can be a great time to learn and try new strategies with options. But it’s not the time to let our human desire for excitement amid boredom and the almost always present desire to make a lot of money trigger terrible decisions.

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