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Chapter 6. Alternatives to Stock Purchas... > The Long-Call Contingent-Purchase St...

The Long-Call Contingent-Purchase Strategy

The first contingent strategy involves buying calls instead of stock. This would be a speculative move if the only purpose was to create profits in call premium. However, as long as your intention is to buy shares, this strategy fixes your future purchase price at the strike price. If you buy calls in several stocks and only some increase in value, you should exercise those calls only on profitable positions. Contingent purchase limits your capital risk. For example, if you spend $500 on call premium and the stock later falls 15 points, you can never lose more than your $500 investment. However, if you had bought 100 shares of stock, you would suffer a loss of $1,500. So, the primary advantage of the long-call contingent-purchase strategy is limitation of risk. Its primary risk is loss of value, notably time value.

If you buy LEAPS calls with a long time until expiration—which is essential in order for this to qualify as a conservative strategy—you pay for the time value. We demonstrate later in this chapter how you can mitigate the long-call cost. For now, the question of whether the contingent purchase is worthwhile is determined by (a) call premium, (b) strike price of the underlying stock, (c) time until expiration, and (d) your desire to fix the price for possible future purchase. One of the more difficult situations occurs when you know that the current price of stock is attractive, but you either cannot afford to buy or are concerned about short-term volatility. Buying LEAPS calls as a contingent-purchase strategy overcomes this dilemma.


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