Buying call options is a good way to gain upside exposure to a hot growth stock. With the market near all-time highs, now is a great time to exercise such a bullish options trade.
Growth stocks have exploded higher in recent weeks. “Old” technology company Amazon (AMZN) is trading higher by 14% year-to-date. And “new” technology companies such as Acacia Communications (ACIA) and Twilio (TWLO) rocketed 53% and 41% (respectively) in recent days.
So is this the start of a growth stock mania that will again create a bubble? Or are these legit companies, creating game-changing technologies?
I recently bought my daughter the newest hot technological gadget, an Amazon Echo. She wanted something that would allow her to play music in her room, and unfortunately the tape decks and CDs from my youth are no longer a preferred sound system. However, I didn’t want to buy her an iPhone or iPad to stream music, as I didn’t want her watching YouTube videos or surfing the internet without adult supervision. Having used her Echo for just a few days, I could not be more impressed. And I’m a bit jealous I don’t have one.
For those not familiar with this new product, an Echo is a small wireless speaker and voice-powered personal assistant that is one of the first commercial applications of artificial intelligence.
What can it do? The better question is what can’t it do?!!
If I want the weather for the day, I simply say, “Alexa, what is the weather for today?” Alexa is the name of the artificial intelligent personal assistant. She will respond with a computerized woman’s voice (think Apple’s Siri) with a detailed answer. Next, I might ask her to tell me a joke, or how many ounces equal one liter. Essentially, Alexa has the answer to all questions, and can also call you an Uber or order you a pizza. Some have called the Echo “Siri on Steroids.”
AMZN, the producer of the Echo, has done well so far in 2016, up 14% year-to-date. And in fact, Mike Cintolo, the Chief Analyst of Cabot Growth Investor, recently recommended the stock to his subscribers. And while many of his readers likely bought the stock based on his recommendation, many others did not want to pay $765 for the shares. Some of those readers, who also subscribe to Cabot Options Trader and Cabot Options Trader Pro, reached out to me for bullish options trades to get upside exposure to AMZN. Those savvy readers understand the amazing power of options trading!
Using Options to Gain Exposure at a Much Lower Cost
A purchase of one call option contract is a bullish position that gives the buyer the right to buy 100 shares of the stock at a set price. For example, if a trader was bullish on fictional stock XYZ that was trading at 18, he could buy one of the 20 strike calls for $2. Because each call option represents 100 shares of the stock, a call purchased for $2 is actually $200.
If stock XYZ were to rally above 20, the trader could choose to exercise his right to buy the stock at 20. So if the XYZ stock price rises, the call’s profit would look almost identical to the stock’s profit. However, if the stock XYZ were to fall, the most the trader could lose is the $200 he paid for this call.
Knowing that buying call options would cost dramatically less than buying the stock, Cabot Options Traders were looking for ways to put on a bullish AMZN position. Instead of paying $76,500 to buy 100 shares of AMZN, I might instead buy one AMZN September 770 Call for $14. The $14 call (as I’ve said) is actually $1,400, which is clearly significantly less than the $76,500 needed to buy 100 shares.
Here is the profit and loss graph of this AMZN call position:
As you can see, if AMZN doesn’t move or falls, the most I could possibly lose on the position is the $1,400 I paid for the call.
However, if AMZN were to explode higher, my calls would jump in value. And at any point, I could decide to exercise my right to buy the stock at 770, or simply sell my calls for a profit. (At Cabot Options Trader, we typically sell the calls out for the profit and not take delivery of the stock.)
Two Other Call-Buying Ideas
I could also use this call-buying strategy if I was afraid of buying the top in any hot growth stocks. For example, if I wanted bullish exposure to Acacia (ACIA)—which is on a meteoric run—instead of paying $10,000 to buy 100 shares, I could buy one November 95 Call for $18, putting just $1,800 at risk.
Or if I didn’t want to chase Twilio (TWLO), instead of paying $6,000 for 100 shares, I might buy one January 65 Call for $8, putting just $800 at risk.
Only time will tell if traders should be chasing stocks like ACIA and TWLO to new highs. And much of the stock’s performance will likely be tied to whether their groundbreaking technologies will become a part of our daily lives, like so many of Amazon’s services.
However, if you have some doubt, and don’t want to put a great deal of capital at risk, buying call options is a great way to get bullish exposure at a fraction of the cost of buying the stock.
To receive more guidance on how to trade calls successfully and see for yourself how to profit from options trading, consider taking a trial subscription to Cabot Options Trader.