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Buying shares vs. buying in-the-money options

Discussion in 'TSLA Investor Discussions' started by SoWrathia, May 17, 2017.

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  1. SoWrathia

    SoWrathia New Member

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    Hi guys,

    New to the forum, but I've been an avid Tesla follower and stock owner for the last 3.5 years. I love this company and what they're doing and I find it incredibly fascinating being able to watch their progress on websites like Elektrek, InsideEVs, TeslaMondo, etc.

    A bit of background about myself - I'm a former Apple stockholder (bought in 2007 and sold in 2014 for a hefty profit). I used that money to pick up my first Tesla shares and I've been accumulating (slowly) ever since.

    The thing is- I've been doing this in all cash and without leverage. A friend recently told me that if I was so confident about TSLA and it's ability to deliver on its promises, and that the share price would rise, why not just buy in-the-money call options and leverage your capital.

    Can someone help me understand a bit more about this?

    Let's say, for example, I have 1000 shares paid for in cash. At roughly $300 per share, my total investment is 300,000. I'm expecting the stock to triple at some point in the next 3-5 years (that's just my personal expectation). So on a returns basis I'd get about 600k in profit from this point onwards.

    Can someone explain how in-the-money call options work? How could I increase my return using the same expectation (3x in 3-5yr), and what are the key risks I should be aware of in doing so?

    Thanks in advance for your input.
     
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  2. rdalcanto

    rdalcanto Member

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    I am not an expert, so I hope I'm not giving wrong information. But let's say you have $30,470 to invest. You could buy 98 shares of stock at 309. If in January 2019 the stock is at 500, you have made just short of $19,000. If instead, you buy 2 calls for strike 160 and Jan 2019 expiration, and the stock is again at 500, you will make $37,600. But, if the stock goes below 160, you lose everything. If it goes to 200, you lose about twice as much as you would if you bought the stock. So from what I can tell, the DIM call at 160 strike price will pay off better than buying stock if it is higher than 309 in Jan 2019. Full disclosure, I just bought the 160 DIM call mentioned here.... :D
     
  3. Johann Koeber

    Johann Koeber Member

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    Stocks and Options are very different creatures.

    If you believe in the company, you can buy stocks. You profit if it goes up. If it goes down you do not sell (if you still believe in the company). You just sit it out.

    With options
    - you are leveraged (greater gain AND greater loss)
    but more important, you are paying a price for this:
    - your options expire eventually
    AND
    - you are paying a price for holding the options because options generally include a time value which decays

    The decay of the time value accelerates as the expiration date comes closer.

    Many people lose money with options. TSLA is just too difficult to time. Personally I like to sell short term options to harvest the time decay. I do hold some TSLA JAN18'19 100 CALLs because their time value is rather low (very little time decay).

    Please learn a lot more about options before putting your savings at risk.
     
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  4. ggr

    ggr Roadster R80 537, SigS P85 29

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    @rdalcanto's reply is great, as far as it goes. He talks about Deep in the Money call options, with a very long time period before they expire. The long time period ones are called LEAPS (an acronym for Long Term Equity Anticipation Security). Here's my amateur explanation that I hope helps with a bit more detail, although there are plenty of online resources, and even some good threads here on TMC if you go looking. For example Newbie Options Trading

    The cost of a call option has two components: intrinsic value and time value. Using his example, the $160 LEAPS have an intrinsic value of (again assuming current TSLA price of $309) of $149 (the difference between those two numbers), and because they are so deep, very small time value. So you are spending effectively around $150 per share to buy them. If TSLA goes up $30, that's 10% increase on your investment if you bought the shares, but 20% increase if you bought the LEAPS.

    The time value is the killer. The further out the expiry time of the options, the larger the time value component will be. Conversely, the closer the strike price gets to the current price, the higher the time component will be; you're effectively betting that the TSLA price will be MUCH higher when they expire. But the leverage is also higher. The shorter the term, and the less In-The-Money-ness, the more such a transaction looks like gambling rather than investing.
     
  5. SoWrathia

    SoWrathia New Member

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    Thanks for this. I clearly need to do more homework, but can I just clarify where you said 'buy 2 calls for strike 160 and Jan 2019 expiration' -

    'buy 2 calls' , how much exposure are you buying? As in what's the # of shares (or value)? What is each individual call made up of?
     
  6. SoWrathia

    SoWrathia New Member

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    I presume DIM is the same as DITM (deep in the money).

    Out of curiosity, why did you choose 160 as the value? Would I be correct in assuming that you believe the share price will never fall below 160?

    What happens if the share price does fall below 160 at any point between now and Jan 19?
     
  7. ggr

    ggr Roadster R80 537, SigS P85 29

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    To answer the questions you asked someone else:
    1. Each option contract (except for ... exceptions... but they don't apply here) is for 100 shares.
    2. He probably chose $160 strike because around half of the current stock price is where the time value pretty much disappears. I think that TSLA is unlikely to fall below $250 ever again, so I don't think that would be the reason. He can speak for himself, though.
    3. Nothing happens, except for the obvious that the options would trade for a very low price, so on paper you have lost a lot of money. The price they trade for at that time would be all "time value", that is, a money representation of the likelihood of the stock price eventually returning above $160 before time runs out. But you can just hold onto them, hoping they get better. On the expiration date, they're either worthless, or worth the difference between the current price and $160, if they are in the money again.
     
  8. rdalcanto

    rdalcanto Member

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    The higher the strike price, the cheaper it is to get a contract (100 shares), but the more volatile it becomes, the more likely you are to lose it all if the stock price drops, and the higher the stock price has to be in the future to break even. I just put a little over $30k in my account. So I could have done one contract at a strike price of $100 (and had some money left over), or done 2 contracts at 160. I could have done 3 contracts at a higher strike price, but the risk starts to increase. For me, 160 was a good compromise, also for the reasons ggr mentioned above in #2. If the SP falls below 160 between now and Jan 2019, but then rebounds to over 310 by Jan 2019, I'm o.k.. If it stays below 160 at the day of expiration, I lose it all (but I see that chance of that happening as basically 0%). Since I am very confident that the stock price will be over 310 in January of 2019, buying two contracts for 160 strike makes me more money than buying 100 shares of the stock at 308. That being said, almost all my Tesla money is in stock. I've just started doing DIM options recently for a little fun. I don't have the balls to move all my money into options, even "safer" DIM options with long expirations.
     
  9. DaveT

    DaveT Searcher of green pastures

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  10. moe.salih

    moe.salih Member

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    Check out Khan Academy's YouTube videos on options. They explain the basics well. Here's the specific segment that explains leverage:

     
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