Updated: Sep 14, 2019
I no longer buy stocks outright.
There's a better way to gain exposure to stocks...while getting triple the returns and having 70% less at risk.
It's through the strategy of buying deep-in-the-money (DITM) call options.
Although I'm a huge proponent of option-selling and currently run a newsletter based on that philosophy, buying DITM call options is the only option-buying strategy that I will ever recommend for consistent use.
Let's look at an example.
In order to buy 100 shares of Intel (INTC), it would cost you $4,800 at its current price.
If you wanted to slash that cost by 70%, and have the opportunity to triple the returns if Intel moves higher, I'm looking at buying the January 2019 $35 call options instead, for a cost of $13.50 per contract ($1,350 total outlay).
Call options can be used as surrogates for stock buying, and that's the way I do it.
Each option contract is equivalent to 100 shares of stock, so you can buy as many option contracts that meet your investing needs.
Now, would you rather pay $1,350 or $4,800 for those same 100 shares of Intel?
If you bought the January 2019 $35 call options for $1,350, you're getting more than a 70% haircut on your cash outlay.
And when buying options, your maximum downside risk is whatever you paid for that option, in this case, $1,350.
If Intel dropped to zero, you couldn't lose more than $1,350 with the call option.
But if you bought the stock, you could lose all of your $4,800 if Intel dropped to zero.
70% less downside risk is very appealing.
Now, if Intel rallied to $60 per share, you'd make 25% on your stock investment (ROI). Not bad.
But if you held the call options and Intel rallied to $60 within the option expiration period, they would be worth $25.00 per option ($2,500), giving you a ROI of 85%.
That's over three times more than the ROI of the stock purchase.
Not many people know the advantages of buying DITM call options over buying the stock.
But we do.
There's one other very important detail to know before embarking on this strategy.
In order to get the best bang for your buck, you need to buy the right strike price, and there's a very specific way to do it.
When buying call options to mimic the stock, you need the call option to move just as much as the stock does, almost point-for-point.
When playing with options contracts, there's almost an endless supply of strike prices to choose from: in-the-money (ITM), at-the-money (ATM) & out-of-the-money (OTM).
Each one of these will move varying degrees in comparison to the stock's move.
How do you choose?
The key with choosing call options to mimic the stock is to pick deep-in-the-money (DITM) strike prices with a Delta of 90% or greater.
Delta is the key here. It is one of the Greek by-products of the option pricing formula and it tells you exactly how the option will perform in regards to the stock's movement.
Having an option with a 90% or higher delta (delta ranges from 0-100%), will assure you that the option will mimic the stock's moves by at least 90%.
For instance, if Intel were to jump from $48 per share to $53 per share, the January 2019 $35 call option should jump from $13.50 per contract to $18.00 per contract. That $5 move in the stock would equate to a $4.50 per move in the option price.
You can easily find the delta from within your option chain feature at your broker.
Here's what such an option chain would look like and how you can spot the delta.
Courtesy Interactive Brokers
In this option chain, the January 2019 options are highlighted, and you can locate the $35 call options on the left side of the screen.
The bid/ask market is showing a value of $13.30 bid/$13.70 ask, giving the option a fair value of $13.50 per contract.
If you look down the Delta column, you will see its value as .908 (90.8%).
At the top of the screen, you will see Intel's last price of $48 per share as of January 31, 2018.
Every option contract has a delta, and the higher the delta, the more it will move in step with the stock.
Now, it's true that an option with a smaller delta will cost less, but at the same time, you won't be getting the same movement out of it.
An option with a 30% delta for example (not shown), will move $.30 per contract in conjunction with a $1 move in the stock.
You want to stick with the high deltas because you get the movement factor, and because it acts more like a true surrogate.
If you would rather have 70% less of an upfront cost, slash your downside risk by 70%, and gain triple the returns, then there's absolutely no reason why you should ever buy another share of stock again. It should be replaced with buying DITM call options.
Now, there are a few things to consider before jumping in:
1. Option buyers don't get to collect dividends. Only shareholders can collect dividends. If this is a big deal for you, you'll need to decide what is more important. Remember, some stocks don't even pay a dividend.
2. Option buyers don't get voting rights. Only shareholders get voting rights. If this is a big deal for you, buy yourself one share of the stock so you can go to the annual shareholder meetings and vote your opinion.
3. Options expire. It's best to choose long-dated options, at least one year out in time.
4. If you don't intend to exercise the call options at expiration (and not take ownership of the shares), you will need to unwind the position and sell the call options back into the market. This will close out the trade completely.
5. If you do intend to exercise the call options and take ownership of the shares (100 shares per each option contract), then you must have the full amount of cash to cover the trade.
6. If you don't want to exercise the shares at expiration but wish to continue with the trade, you can "roll" the trade forward which entails selling the original call options back to the market and re-establishing a new long-term DITM call option buy trade. This is the method I choose.
Lastly, this is a bullish strategy. You must be bullish on a stock in order for it to work.
If you are indeed bullish on a stock, consider this strategy before buying the shares. It can save you lots of upfront cash, reduce your downside, and increase your returns.
We use this same exact strategy to piggyback Warren Buffett and gain access to all his investments for 70% less cost. See my report here.
What are your thoughts? Give me you comments.