The Power of Options

July 31st, 2007

Options can open up a lot of… err, options… Okay, bad opening line. There are many advanced strategies for options and perhaps I’ll discuss those later. Right now I’m going to focus on the benefits of using a simple options strategy. As you know, I’m a fan of longer term investing so it might not surprise you to hear I hate short term options. Long term options (several years) and warrants (often long term) are a great tool that many investors may find useful. I would use these tools in conjunction with my value/growth fundamental based investing.

Okay, so pretend you have ~$10,000 in cash. Pretend you believe Yahoo will do incredibly well over the next three years (from now) due to the release of their international publisher network and the internet growth that is bound to occur. Do you know how much stock you can buy with $9,500? At the current price of $23.50 you can purchase about 400 shares. But, if you use options you can buy 4 January 2010 $20 Call Options and control that same 400 shares for $3,360! And that’s WITH paying the $8.40 per share premium! You can find other options that don’t have such a high premium and control shares for much less money in percentage terms.

Now what do you do with the other $6,140? You can either purchase MORE shares in Yahoo to take advantage of the gain you believe will occur, or you can invest that money in other companies. I’m thinking of using something similar to this strategy. Here is what I will do. In the example of Yahoo above, I would purchase 6 options contracts (which would come to ~$5,000. I would then take the remaining $5,000 and put it into high yielding stocks to get some passive income. This way, I’m able to take advantage of high growth stocks and grow passive income at the same time. In the end, my goal is to have enough passive income to retire and live comfortably. Options will give me the ability to control more growth stocks with less money. Now that is power. Yes, I know there are increased risks when leveraging money, but I think the potential benefits may outweigh the risks if fundamentally strong companies are chosen.

Entry Filed under: Options & Warrants