Some of you may think it is too early for everything pumpkin-flavored, but I am all about it. Here are some of the pumpkin-flavored items we currently have on hand: beer, coffee, creamer, cereal, cake mix, bagels, pop tarts, and cocoa. Can you really have too much of a good thing?
Similar to everybody feasting on all things pumpkin-flavored, investors have been gorging themselves on bullish stock options over the last month. For the first time ever, the volume in stock options was higher than the volume on the stocks themselves.
Too much pumpkin coffee? No, it is pure greed and speculation. Options allow buyers to control large sums of a stock without actually buying the stock. Each bullish options contract allow the buyer to buy 100 shares of the underlying stock at a predetermined strike price on or before the expiration date for a fraction of the cost of buying the stock itself. Here’s an example:
An Example Using Apple (AAPL)
AAPL’s price is at $110/share. You predict the price will go up, but don’t want to invest the $11,000 needed to buy 100 shares. You check to see what bullish options, called call options, cost one month out:
- Underlying Investment: AAPL
- Strike Price: $110/share
- Expiration Date: 10/16/2020
The cost is $600 ($6/share X 100 shares). For only $600, you can make (or lose) money as if you had invested $11,000. Here are some possible future outcomes:
- AAPL = $116 – Since you paid $6 for the right to buy the stock at $110, you will need AAPL to be above $116/share to make any money.
- AAPL = $120 – You can either buy the shares at $110/sh or you can sell the call option for $10/sh, or $1,000. This would represent a $400 profit on your $600 investment, or a whopping 66% return in a month. This is fun!
- AAPL<$110 – You lose the entire $600, equating to an 100% loss. Ouch. Not fun.
All the elements of speculation are here: Invest a small amount of money for a short time to win big – what could go wrong? The answer here is plenty. You have to name both a time and a price to win. Furthermore, the option prices adjust based on the volatility of the stock, so you need to assess and factor in the volatility as well. There are option strategies that can complement your portfolio more conservatively, but buying options alone is basically gambling. Just ask Joe Namath: “Do they have to pay anything to play? Do they win something? It’s gambling.”