Options Trading Return on Investment

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Information about Options Trading Return on Investment
News & Politics

Published on February 19, 2014

Author: InvestingTips

Source: slideshare.net

Description

Options Trading Return on Investment

Options Trading Return on Investment

The point of stock options trading is the return on investment of time and money.

The best options trading return on investment comes from hedging risk and the investment leverage inherent in options trading.

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A good options trading system takes both of these requirements into account.

Let us look at the basics of options trading and at options trading return on investment under two trading scenarios.

Buying Options

Stock options buyers purchase call contracts or put contracts.

A call gives the buyer the right to purchase stock at the strike price or contract price no matter how high the price of the stock might rise.

The buyer is under no obligation and simply pays a premium to buy stock under contract conditions if doing so will be profitable.

Buying puts gives the purchaser the right to sell stock at the strike price no matter how low the price might fall.

In each case the buyer of an option limits his risk to the price of the contract.

And, when a buyer pays the premium to purchase an options contract this price is substantially less than the price of the stock.

Options Trading Return on Investment Example

As an example, a trader pays $300 for $102 call options on XYZ Company which currently sells for $100 a share.

Based on his research he believes that the price of the stock will go up.

The strike price of the contract is $102 so the price of the stock needs to go up above $105 a share for the trader to make money on the contract.

Let us say that his fundamental stock analysis and technical market analysis are correct and the stock goes up to $115 a share.

He will pay $102 a share if he executes the options contract and then he will sell the stock for $115 a share for a $13 a share profit or $1,300 for 100 shares.

He paid $300 for the premium so his options trading return on investment is $1,000 on a $300 investment.

On the other hand he could have purchased the stock at $100 and sold at $115 a share when it went up.

But since he only had $300 he could only have purchased three shares so he would have made $45 on a $300 investment.

If he had chosen to buy 100 shares of the stock he would have made $1,500 on a $10,000 investment.

Here two tables showing the results of the three scenarios when the stock goes up from $100 to $115 and also three scenarios for when the stock goes down from $100 to $85 in price.

XYZ Stock Goes Up from $100 to $115 Which of three choices Investment Return Rate of Return Buy calls on 100 shares $300 $1,000 333% Purchase three shares $300 $45 15% Purchase 100 shares $10,000 $1,500 15%

XYZ Stock Goes Up from $100 to $115 Which of three choices Investment Return Rate of Return Buy calls on 100 shares $300 $1,000 333% Purchase three shares $300 $45 15% Purchase 100 shares $10,000 $1,500 15%

These tables demonstrate our point about options trading return on investment as well as hedging risk.

When a stock goes down in price it is better to have held call options than to have bought the stock as the risk is limited by the cost of the options premium.

When the stock goes up in price it is better to have purchased calls than to have bought the stock as the options trading return on investment is 333% while the return on investment in this case is 333% while the return on investment from purchasing the stock is 15%.

Of course this is simply a hypothetical example but please use it as an educational example regarding options trading return on investment.

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