[iv] Why US stock options and what is the difference with stocks?

In the screen shot from my TOS (thinkorswim) account above shows Starbucks shares (SBUX) trading on 4/Aug/2011 at about 10:30EST. We like to buy Starbucks shares (SBUX) but we also like to maximise our return (ROI) with the limited capital that we have.

Say we have only $4,000.00 (USD) and we have the following choices:-

SBUX	STARBUCKS CORP
04-Aug-11	10:30EST
UNDERLYING		bid	ask	done
		38.59	38.61	38.60
OPTIONS
CALL	STRIKE	O/I	I/V	DELTA	PRICE
Oct'11	38	1936	30.1%	0.57	2.40	ITM
(78 days)	39	1695	29.5%	0.49	1.88	OTM

So with $4,000.00, we can buy:
(1) 100 shares of SBUX @ $38.60 or
(2) call option ITM at premium price of $2.40 for 16 contracts
(3) call option OTM at premium price of 1.88 for 20 contracts

Now, say SBUX rise by $1.00 to $39.60, the call option premium will also rise

SBUX stock price increase by 1.00 to 39.60
CALL	STRIKE	PRICE
Oct'11	38	3.04
	39	2.44

So if we sell our 100 shares of SBUX or the call options, we can enjoy the following return:-

ROI of SBUX		bought	sold	profit	ROI
stock price		38.60	39.60
100 shares		3,860.00	3,960.00	100.00	2.6%
Call option ITM		2.40	3.04
16 contracts		3,840.00	4,864.00	1,024.00	26.7%
Call option OTM		1.88	2.44
20 contracts		3,760.00	4,880.00	1,120.00	29.8%

Imagine the huge leverage of returning a high of 26% to 30% if we buy call options compare to buying the stock and make less than 3%.

On the hand, it can also be a huge risk of heavy losses if the stock does not rise but goes bearish.

Hence, trading US stock options can be highly risky and not for everyone except those who have risk capital, afford to lose a little and have the right knowledge to trade. In the coming posts, I shall explain the following:-

•  psychology of trading and how to make it mechanical
• stock selection criteria (fundamental, T/A, PVA, candlestick)
• entry point, risk-reward ratio and setting stop loss
• art of selling
• basic foundation of US options trading (stock, index, ETF)
• psychology of money management (cash, margin, CFD)

Be patient when you buy a trade but decide quickly when you sell.