Call Options

Buying a call option gives you the right (but not the obligation) to purchase 100 shares of a company’s stock at a certain price (called the strike price) from the date you buy the call until the third Friday of a specific month (called the expiration date).

People buy calls because they hope the stock will go up, and they will make a profit, either by selling the calls at a higher price, or by exercising their option (i.e., buying the shares at the strike price when the market price is higher).

Call options are quoted in dollar terms (e.g., $3.50), but they actually cost 100 times the quoted amount (e.g., $350), plus an average of $1.50 commission (charged by my discount broker — commissions charged by other brokers may differ).

Since most stock markets go up over time, and most people invest in stock because they hope prices will rise, there is more interest and activity in call options than there is in put options.

Real World Example of Call Options

Here are some call option prices for a hypothetical XYZ company on November 1, 2010 (price of stock: $45.00):

Expiration Date
Strike Price	Nov ’10	Dec ’10	Jan ’12	Terminology of Option (price of call option)
40	$5.50	$7.00	$18.50	“in-the-money” (strike price is less than stock price)
45	$2.00	$4.00	$16.00	“at-the-money” (strike price is equal to stock price)
50	$0.50	$1.00	$14.00	“out-of-the-money” (strike price is greater than stock price)

The premium is the price a call option buyer pays for the right to be able to buy 100 shares of a stock without actually having to shell out the money the stock would cost. The greater the time period of the option, the greater the premium.

The premium (same as the price) of an in-the-money call is composed of the intrinsic value and the time premium. (I understand that this is confusing. For in-the-money options, the option price, or premium, has a component part that is called the time premium). The intrinsic value is the difference between the stock price and the strike price. Any additional value in the option price is called the time premium. In the above example, the Dec ‘10 40 call is trading at $7.00. The intrinsic value is $5 ($45 stock price less 40 strike price), and the time premium is $2.

September 11, 2023

September 12, 2023

Dear [[firstname]],

No marketing this week … you deserve a week off. Let’s get to the trade …

Here is your Option Trade of the Week, as given to our Terry’s Tips Insider Members as part of the Saturday Report. With no earnings reports to play with, I’m going with an ETF that hasn’t done a whole lot lately. To make the trade more attractive, the credit went up slightly today (for a change), so you should be able to enter tomorrow at a decent price.

Good luck with the trade …

Health Bear … Sort Of

With no notable earnings reports this week, we’re turning to an ETF that’s done little of late. It’s the SPDR Health Care ETF (XLV), which holds such heavyweights as UnitedHealth Group (UNH), Eli Lilly (LLY), Merck (MRK), Johnson & Johnson (JNJ) and Amgen (AMGN) among its top 10 holdings. This trade is a bearish credit spread, though I’m not particularly bearish on the sector. I’m not bullish, either. But that’s the beauty of credit spreads. You can be more neutral than directional and still collect a maximum profit so long as the short strike remains out of the money. It’s a forgiving strategy that caters to those who don’t have a strong directional bias.

I’m using a bearish call spread for this trade because the overhead 135 level has proven difficult for XLV to overcome throughout most of 2023. In fact, the ETF has closed above this mark only a handful of times since January. Recent attempts to take out 135 were rejected in April, August and July.

Although XLV currently sits below all its major moving averages, it hasn’t respected these trendlines for support or resistance for much of the year. So, even though the 20-day, 50-day and 200-day moving averages lie between the current XLV price and the 135 level, I’m not relying on their potential for resistance. This is more about the 135 level acting as a top in recent months.

Note that this trade extends into the start of the next earnings season. In fact, four of XLV’s top 10 holdings, including UNH and JNJ, report before the spread expires on Oct. 20. However, given XLV’s performance this year (down around 3%) and the fact that it’s gone nowhere for seven months, I’m not expecting earnings from a few XLV names to give the ETF a huge shot in the arm prior to expiration.

If you agree that XLV will continue its “meh” performance, consider the following credit spread trade that relies on XLV staying below $135 (blue line) through expiration in 6 weeks:

Buy to Open the XLV 20 Oct 137 call (XLV231020C137)
Sell to Open the XLV 20 Oct 135 call (XLV231020C135) for a credit of $0.40 (selling a vertical)

This credit is $0.04 less than the mid-point price of the spread at Friday’s $132.06 close. Unless XLV sinks sharply at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $38.70. This trade reduces your buying power by $200, making your net investment $161.30 per spread ($200 – $38.70). If XLV closes below $135 on Oct. 20, the options will expire worthless and your return on the spread would be 24% ($38.70/$161.30).

Thank you again for being a part of the Terry’s Tips newsletter.

Happy trading,

Jon

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September 5, 2023

With the market throwing off bullish vibes this week, we’re going with another bullish trade on one of the few notable names that reported earnings this week: athletic apparel maker Lululemon Athletica (LULU). The company reported solid numbers after the bell on Thursday, including an 18% revenue jump that surpassed the analyst estimate. Earnings also handily beat expectations. To complete the trifecta, full-year revenue and earnings guidance came in above the analyst estimate.

Analysts were seemingly thrilled with the numbers, as a slew of price target increases poured in. But many raised the price by only a few dollars, which is meaningless for a $400 stock. After the flurry, the new average target price stands only around 3% above Friday’s close. And there were no ratings changes, leaving the current consensus in the buy/outperform category.

So, while analysts appear bullish, nobody seems willing to bet the mortgage payment on LULU. I’m fine with that, however, as I hesitate to jump on a bandwagon that’s already full. I like to see some room for upgrades and target price increases.

Traders apparently thought differently, pushing LULU up 6% on Friday to an 18-month high. It also propelled the stock above a trading range that has captured most of the price moves of the past five months. Note in the chart how the 20-day and 50-day moving averages have combined forces near the 380 level. I expect these trendlines to rise above the top of the range around $385 within the next week or two. That should provide a multi-layered tier of support to keep the short put of our spread out of the money.

The other technical driver of this trade is the fact that LULU tends to stay flat for several weeks after earnings. That is, the stock doesn’t tend to stray too far from its initial post-earnings move. Given that we have around a 5% cushion combined with the trading range and potential trendline support, I like the odds of LULU staying above the key $385 mark through expiration.

If you agree that the stock will respect the top of its trading range, consider the following credit spread trade that relies on LULU staying above $385 (green line) through expiration in 6 weeks:

Buy to Open the LULU 13 Oct 380 put (LULU231013P380)
Sell to Open the LULU 13 Oct 385 put (LULU231013P385) for a credit of $1.05 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $404.19 close. Unless LULU surges at the open on Tuesday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $103.70. This trade reduces your buying power by $500, making your net investment $396.30 per spread ($500 – $103.70). If LULU closes above $385 on Oct. 13, the options will expire worthless and your return on the spread would be 26% ($103.70/$396.30).

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August 7, 2023

Room to Run

Although this was the busiest week of earnings season – loaded with big tech names – we’re going to wade into calmer waters with Marriott International (MAR). The company runs the gamut of hotel offerings, operating under 30 brand names in 138 countries. The company reported on Tuesday before the open, beating estimates on both revenue and earnings. The hotelier also raised its Q3 and FY 23 earnings projections, which also are above expectations. MAR’s CFO noted that domestic travel demand continues to grow while international markets are starting to heat up. Business and group travel is also improving.

Analysts were less than ebullient toward the news, however. While the stock received several target price increases, there were no ratings changes. In fact, MAR’s average analyst rating sits between a buy and hold. The average target price ranges from $203 (right on its current price) down to $177, depending on the data source. And this is after the target increases. Either way, this is at best a sluggish endorsement of the stock, which is consistent with the ratings.

In contrast, MAR’s chart tells a more bullish story. The stock traded slightly higher after earnings through Friday amid a lower market. But the shares are up 36% in 2023, putting it on par with MSFT. Since late June, MAR has been on a solid rally covering 19% that included an all-time high on Wednesday. Currently, the stock has been trading well above its 20-day moving average, a trendline the stock has stayed close to throughout the runup. Note that the short strike of our put spread is at 195, a mark the 20-day just moved through.

This trade is based on MAR’s positive outlook, support from the 20-day moving average and analysts (hopefully) realizing that they have been too cautious toward the stock. MAR’s performance this year deserves better than what analysts have grudgingly offered.

If you agree that the stock will continue to respect its trendline support (blue line), consider the following credit spread trade that relies on MAR staying above $195 (red line) through expiration in 6 weeks:

Buy to Open the MAR 15 Sep 190 put (MAR230915P190)
Sell to Open the MAR 15 Sep 195 put (MAR230915P195) for a credit of $1.05 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $202.98 close. Unless MAR surges at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $103.70. This trade reduces your buying power by $500, making your net investment $396.30 per spread ($500 – $103.70). If MAR closes above $195 on Sep. 15, the options will expire worthless and your return on the spread would be 26% ($103.70/$396.30).

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Call Options

Real World Example of Call Options

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Call Options

Real World Example of Call Options

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Making 36%

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