Mon Feb 13, 2006: Buying GOOG Call Options

Most of the option information on this web site is devoted to the analysis of option writing (selling) strategies, but there is a limited amount of option buying information.

In the future there will be more data for additional strategies.

The purpose of today's commentary is to show how the table data can be used to compare buying call options at various strike prices.

For now I'd like to give an example of buying call options on GOOG stock because today the stock got near its 200-day moving average after a big month-long correction.

Some investors believe the stock will fall further. Others think it will bounce back. For this commentary I'm not going to make a prediction, just look at an example.

Often stocks do find support near either their trendlines or their moving averages. Google's 200-day moving average is currently at 333.83 and the stock closed today at 345.70 after reaching a closing high 471.63 one month ago Jan 11th. This is a dip of 26.70% from the high. Call option buyers usually try to wait for dips in an uptrend before buying. This has certainly been a big dip!

I don't like to buy call options with only 4 days left before expiration so I'm going to ignore the February calls.

Looking at the March calls, I'd like to compare the March 350 call which is just out of the money with the March 320 call which is in the money.

Which would be better to buy?

That depends on your expectation for the stock price between now and expiration day Friday March 17th. Assuming you expect the stock to go up and are willing to accept the risk of losing all your money if it doesn't, let's look at how far it will have to go up by expiration to breakeven or to theoretically double or triple your investment.

On a breakeven basis the 320 calls are superior because the breakeven price is only 356.40 versus 367.70 for the 350 calls.

Investors whose goal is to double their money might choose to buy the 350 calls though, because the double point is 385.40 versus 392.80 for the 320 calls.

And even more aggressive investors, determined to triple their money in one month, might also prefer the 350 calls, which would triple if GOOG closes at 403.10 versus a much further away target of 429.20 for the 320 calls.

It comes down to a tradeoff of risk versus reward. The 320 calls are more likely to provide some profit while the 350 calls have a bigger payoff if the stock moves sharply higher.

In any case, only experienced option speculators who can afford to lose their entire investment in a short period of time should be involved in this risky strategy at all. Google stock has been in a strong downtrend and there is no guarantee it will turn around anytime soon.

But for the rest of you I hope this example has been informative.

Best of luck with your option investments!