Call Options: A Beginner's Guide to Leveraged Investment Strategies

This article is a start in learning to make money with call options. Call options afford the investor with great flexibility to make leveraged investment returns. Some of the benefits include the following: stock replacement, greater leverage, portfolio complements and lower capital requirements.

Stock Replacement

When you are closing the position for stocks, if the investment has been held for a year or more, the capital gains will be taxed at the lowest capital gains tax rate. Otherwise, these gains are taxed as personal income tax. A stock replacement portfolio can mimic the portfolio of the actual stocks. Options give a great deal of flexibility to the investor, in using different calls and puts to make the portfolio steadier when times get rough.

Leverage

One of the major benefits of trading call options is that this gives the investor a great deal of leverage. For stocks, the leverage is 100:1 for profits. That means that they are riskier yet require less money to make the same amount of profits in the long run. The best strategy for making use of the leverage is buying deep in the money calls when the market has dropped to a level that the investor believes is a bottom. Normally, bottom guessing is not a good money management technique for stock investing. When you are trading risky call options, bottom guessing is surprisingly ideal because of the amount of money that can be made in a short period of times thanks to the leverage and fast market rebounds.

Portfolio Complement

A professional money manager will almost always look to derivatives to help manage the portfolio. Money managers make use of stock replacement portfolios and write call options using the covered call strategy for certain managed funds.

A basic portfolio that mimics the returns of the Nasdaq100 with funds of $10 million, for instance, can buy a basket of call options when the money manager believes the Nasdaq100 has reached a ceiling that is not sustainable. So long as the basket of call options equals the size of the portfolio at the time of expiration, the position is covered. In other words, the risk is limited and so is the gain from reaping the premium from the underwritten calls. This strategy is what is known as a covered call write.

In the case where the manager wants to underwrite more calls than the portfolio has collateral for when all is said and done, this leaves room for unlimited risk, yet the gain is still limited. Therefore, many professional money mangers will not view this strategy as sound for the purposes of managing a retail portfolio, although it is used commonly in the commodities trading realm and by brokers. The strategy is known as a variable ratio write.

Lower Capital Requirements

Finally, the other major factor for trading call options is lower capital requirements. This allows the investor to pick up more positions than what would normally be feasible in trading stocks. Normally, this allows the investor to start with a lower minimum investment.