The great advantage to the man who buys puts and Calls is that his risk is always limited. Another advantage is that he saves payment of interest. For instance, if you buy a Call and the stock moves up in your favor, For 30 days you do not have to pay any interest until you have called the stock and it has been delivered into your account.
Since the Securities Exchange Commission, has raised margin requirements to Where
it requires 55% margin to buy stocks, it makes it a great advantage to buy Puts and Galls.
For example : If you wanted to buy 100 shares of stock selling at $100 per share , you
would have to put up $5,500 margin and would expect it to go up more than 5 points if
you bought it, therefore instead of putting up $5,500 to buy the stock and carry it and
besides pay interest, you buy a Call, we will say, 5 points away for 30 days, which costs
you $142.50. Then if the stock advances during the 30 day-period to where you have a
profit of $1,000, you have made nearly 100% on your money, On the other hand, if you
put up $5,500 and the stock advances so you have a profit of $1,000, your net return on
your capital would be less than 20%,while at the same time If you bought 100 shares o£
stock, on margin, it might decline 10 or 20 points and your loss would be 10 or 20 points
according to whether you held it or used a stop loss order and limited your risk.
How to use puts and calls in place of stop loss orders
Another advantage in buying Puts and Calls is to protect the stock that you already
have bought or to protect the stock that you are already short of. When markets are very
wild and active and unexpected events take place that cause stocks to open up or down
several points, as has happened many times in the past and will happen again in the
future, you want to be protected against losses. You can always use a stop loss order, but
i£ the stock should open off 3, 4, or 5 points under your stop loss order, then your stock
will be sold at the market. On the other hand, if you had 100 shares of Chrysler bought at
100 and it declined and closed some night at 97 and you had a stop loss order at 95 and
something unexpected happened overnight and the next morning the stock opened at 90,
your stock would be sold on stop at 90 at the market and you wou1d lose 5 points more
than you expected to lose by placing a stop loss order. If instead o£ placing a stop loss
order when Chrysler was selling around 100, you bought a Put at 95, than when the stock
opened at 90 and continued to 80, your stock would be protected at 95 or you could
deliver it at 95 on the Put and would not lose anything by the overnight drop, the Put
having protected you against the unexpected.
Reverse the position. Suppose you are short of Chrysler at 100 and have a stop lass order
on it at 105. If the unexpected happened and Chrysler opened at 110, then your stop loss
order would be executed 5 Points higher than you expected and you would lose $500 or 5 points more than you had figured on. On the other hard) if you had a Call
bought on Chrysler to protect your short sale and Chrysler opened 5 points above your
stop loss order some morning, then the Call would protect you because you would have
a contract to buy the stock at a price on the call; Call and you could call it and deliver it
against your short sale.
Thus , you see that you can use Puts or Calls for insurance or for protection when
you are long or Short of the market just the same as you use; them to limit your risk in
getting in and out of the market, limiting your loss to the amount you pay for a Put or a
Call, ;when you want to take advantage of a Stock that you think may have a fast move
one way or the other.