Investing in a stock generally requires you to pay the share price , multiplied by the number of shares bought. However, there is an alternative method that requires less capital: This is done by using " in the money " call options that mimic the movement of the stock. The option is an American call option. If you have a short-term investment horizon , you could probably take a call option expiring on October 18 of as shown in the table above.
Each option represents shares of Google. The strike price is the price at which you have the right but not the obligation to buy the stock. The price you pay to have this option is the premium price or the last price. As the strike price decreases, the call option is deeper in the money and the premium also increases.
Since the delta of the option is 1, any change in the stock price should move the option price by the same amount. Another benefit of investing in Google or any other company using options is the protection an option carries if the stock falls sharply. The fact that you don't own the stock but only the option to buy the stock at a certain price protects you if the stock takes a plunge.
This is because you will only lose the premium paid for the option instead of the actual value of the stock. Longer-term options are relatively more illiquid than shorter-term options and therefore the transaction costs in the form of bid-ask spread would be higher.
Figure 2 shows the number of trades for call options expiring in June are less than in the March expiry, which is less than the October expiry. Therefore, it becomes quite expensive and difficult to invest in a stock using options for the long term. One alternative is to roll over the options at each expiry, but this would also increase transaction costs in the form of higher brokerage fees. For some companies and other securities, there are also mini-options for which the underlying is 10 shares instead of This is useful for smaller investors and for hedging odd lots of a particular stock, i.
Unfortunately, the volume in these options is not high and mini-options are not as common as regular options. Using options is a cost effective way to gain exposure to a stock without risking a lot of capital and still being protected on the downside. One of the main drawbacks is the liquidity of the option contract itself. If you are an investor interested in investing in companies with a high stock price i.
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Become a day trader. The Bottom Line Using options is a cost effective way to gain exposure to a stock without risking a lot of capital and still being protected on the downside.
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