Buying Options

The most basic of options strategies is to simply buy call or put options. When you buy options, you are said to have a long position in that option. You have a long call position when you buy calls or a long put position if you buy puts.

Generally, when you are bullish on the underlying asset, you can buy call options to implement the long call strategy and when bearish, you buy put options to implement the long put strategy.

In both cases, you hope that the underlying stock price move far enough to cover the premiums paid for the options and land you a profit.

Cost Considerations When Buying Options

The price you pay to own the option is called the premium which is affected by many factors such as moneyness, time to expiration and underlying volatility.

Moneyness

Out-of-the-money options are cheaper to buy than in-the-money options but they are also more likely to expire worthless.

For call options, this means that the higher the strike price, the cheaper the option. Similarly, put options with lower strike prices are therefore less expensive to purchase.

However, the size of the premium alone does not tell us the whole story. In fact, at-the-money options can be considered the most expensive even though their premiums are lower than in-the-money options. This is because their time value is highest and time value is the part of the premium that will waste away as the expiration date approaches.

Time to Expiration

Obviously, the longer the time to expiration, the more chance the option buyer have for the underlying price to move in the right direction and therefore the more expensive the option.

Implied Volatility (IV)

Watch out for the implied volatility (IV) when buying options. Options are more expensive when the IV is high and less expensive when it is low.

Selecting the Right Option to Buy

Which strike price and expiration you choose all depends on your outlook of the underlying. For instance, if you believe that the underlying will make an explosive move upwards very soon, then it makes sense to buy an at-the-money call option expiring in the nearest expiration month.

Buying Options for the Purpose of Hedging

Other than speculation, options can also be bought as a means to insure potential losses for an existing position in the underlying. To hedge a long underlying position, a protective put can be purchased. Similarly, to protect a short underlying position, a protective call strategy can be used.

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