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When Call Buying is a Good Idea

September 17, 2009 By Steven Place

Look. The market is overbought. We're seeing some signals (% above 200DMA) that we haven't seen in years, and some other signals (ISE P/C data) that we haven't seen in months. So while it doesn't make sense to go full on short, how do we still trade this market in the context of the current structure?

This is where options really come into play. Buying calls offer limited risk and unlimited reward, and they don't require too much capital to put on. The tradeoff is the premium, or extrinsic value, you have to pay to have the opportunity to limit your overall risk. That premium is related to the volatility of the underlying.

So if you are buying calls, you have to be bullish on both price and volatility. In other words, you are buying calls because you believe that the underlying is going to move faster than what the options are pricing in.

Combine that with stocks volatility at or nearing 52 week lows, and it might be a good time to pick up some calls. Do note that the overall trend in volatility is still down-- so I would be much more keen to own vol in individual names rather than indicies or sectors.

Over this past week, we've been implementing that thesis in IWO's premium service. With the market so overbought, we don't want to deploy a huge amount of cash, but we still want to trade some bullish momentum. Here's some of the play's I've sent out on my blog, over email, and through stocktwits:

EOG - Bot 5 Oct 80 Calls for 2.60 - Sold for 5.00 - Total profit $1200 or 92%

MRO - Bot 4 Oct 32.5 Calls for 1.70 - Still open at 2.425 - Open profit of $300 or 44%

AGU - Bot 5 Oct 55 Calls for 1.40 - Sold for 2.00 - Total profit $300 or 42%

There's plenty more opportunities like this coming, if you're interested in plays like these as well as other complex option strategies to help hedge against risk, join my Premium Service

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