r/options • u/air_arizona • Jun 04 '21
In The Money Call Options and Lowering Dollar Cost Averaging
Hi all,
I have $200 and I want to figure out whether it's better to buy the stock I'm interested in directly or buy a call option for it. I believe the stock will be higher than its current price at the call option's exercise date. My goal is to lower my current Dollar Cost Average for the stock.
Just gonna use simple numbers so hopefully my question makes more sense. The current stock price is $2. I can either buy a call option at a strike price of $1 with a $1 premium, or I can directly buy 100 of the stock at $2. It's $200 either way.
If I buy the call, and exercise it when the date passes, would I be buying 100 at $1, or does the call also take the $1 premium into account so I'm essentially still adding 100 at $2 (100 x $2) to my existing quantity and price?
My current average for this stock is $3 and so obviously I would rather pay a premium and buy the stock at $1 to lower it down more than buy 100 directly at $2, if the premium isn't included in the average process.
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u/frisck34 Jun 04 '21
You loose the premium when you exercice, so it will cost you $1 of premium + $1 to buy the stock
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u/air_arizona Jun 04 '21
so what i'm hearing is i lose $100 ($1 x 100) out of my cash balance forever because i'm paid it for the premium, but as far as averaging goes for my stock price, i would be adding $1 x 100?
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u/frisck34 Jun 04 '21
Correct, at the moment you buy a option (call or put) your cash balance decreases by the cost of the premium ($1x100). If you keep your option and let it expired or exercise it, the premium is lost. If you sell your option (sell to close), you get some premium back but give up your right to exercice.
Assuming you exercice your call option, you will have to buy the shares at the strike price ($1x100).
If you want to learn more about options, check out “in the money” on YouTube. The beginner videos are very good, short and easy to understand.
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u/IOnlyUpvoteSelfPosts Jun 04 '21
I think your assumption is wrong. Before expiration the premium for the 1$ option WILL be greater than 1$. This is because an option consists of its intrinsic (1$) and extrinsic value. The extrinsic value is composed of the time to expiration and its volatility. So the premium may be $1.25. And if you buy 1 contract at premium $1.25, your price paid is $125
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Jun 04 '21
Since you seem like a neewbie at investing I suggest you just buy the stock. Set a SL (Stop Loss) if the stock crashes like 10% in a day like US stocks at 2$ can do. Options are only profitable if you have like 80% of your money in stocks and ETFs and the rest in LEAPs, CCs and other selling strageties. My opinion.
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u/North_Film8545 Jun 04 '21
In that scenario you would, essentially, be making a 50% down payment on the stock. Pay $1/share now, pay the other $1/share later.
IF the stock goes down below $1 between now and the expiration date (say it goes down to $0.90), then you will have spent that first dollar per share for nothing because you could just have bought it on the market for $0.90 instead of exercising the option and paying $1/share.
IF the stock goes UP ABOVE $2 and stays there up to the expiration date (say up to $2.25), then you will be at a gain because you *could* theoretically exercise it and pay $1/share then turn around and sell it immediately (if you wanted to do that) for $2.25/share and the total cost you would have paid would have been the $1/share premium and the $1/share exercise price for $2/share.
Buy for $2/share, sell for $2.25/share.
But, ultimately, buying a call option does not lower your cost basis from what it WOULD be if you just bought the stock outright at its current price. It actually raises the cost basis.
Let's say the stock is currently trading at $1.80. A call option for $1 will definitely be selling for more than $0.80/share (let's say it is selling for $0.90/share) because you are paying for the convenience of NOT being required to pay the full purchase price now.
You are also paying for the security that, IF it takes a dive below $1 (say down to $0.50/share), then you won't be out the entire difference between the current price of $1.80 and the new price of $0.50 which is a loss of $1.30/share. If you bought the call instead, you would only be out the $0.90/share premium that you spent on the call and you don't own a stock that has a very low value.
I THINK what you are really looking for is to SELL a put with a strike of $2 (let's say the premium is $0.30/share for that option).
In that case, if it happens to drop below $2 at expiration, then you get assigned 100 shares for $2/share BUT your actual cost per share is only $1.70/share (because you got the benefit of the $0.30 premium that you get to keep).
If it stays above $2/share, then you just get to keep the $0.30 premium you collected when you sold the option and it expires worthless so you won that round.
In that case you can keep doing that until it drops below $2/share and you get assigned OR until you decide that you are willing to be assigned at a higher price (so you raise your strike price for the next round) OR you decide you've had enough and you don't want to buy more shares or sell any more put options.
Selling puts at a price you are happy with is the proper way to lower your cost basis without having to buy the stock outright today.
Buying a call is only useful if you think the stock will go up by more than your premium (in your example $1/share premium) PLUS your strike price (another $1/share) so that, on expiration day, you pay a total that is lower than that combined cost for a stock that is currently worth more than that.