Why call options are more profitable compared to stock trading?

Question

I am having a hard time trying to understand why buying call options are more profitable (if you predict the market right), compared to selling & buying stocks right away. Let me explain my confusion with an example:

Let's say the stock price of GME is currently 10 dollars. I buy a call option to have to right to buy it for 10 dollars, I pay 2 dollars for this. Then let's say that GME hits 20 dollars. I exercise my call option, and in the end I make 8 dollars of profit.

However, wouldn't I make more profit if I bought the share for 10 dollars, and sold it for 20 dollars? Wouldn't this approach give me 10 dollars of profit?

Answer 1

Suppose you have $100 in the bank, and you want to invest in Company X. Company X starts trading at $10, and an option costs $2.

We will look at four possible scenarios.

• No options, stock goes up: You buy 10 shares of X at $10 each. X then goes up to $15, so you sell the shares.
  • Outcome: You made $50 on an investment of $100.
• No options, stock goes down: You buy 10 shares of X at $10 each. X then goes down to $5, and you sell the shares.
  • Outcome: You made -$50 on an investment of $100.
• Use options, stock goes up: You buy options in 50 shares of X at $2 each. X then goes up to $15. You then sell the options themselves for $4 each ($200 total) to someone else who wants to exercise them.
  • Outcome: You made $100 on an investment of $100.
  • The person who bought the options from you made their own profit of $50. (Bought options for [50*4=] $200, exercised options for [50*10=] $500, sold shares for [50*15=] $750.)
• Use options, stock goes down: You buy options in 50 shares of X at $2 each. X then goes down to $5, so you let the options expire.
  • Outcome: You made -$100 on an investment of $100.

So you can see how options can amplify both your profits and your losses.

Answer 2

Buying the shares at the start would cost you $10 upfront. Buying the call option will cost you $2 upfront.

Of course sometimes the $2 is wasted and you never purchase the stock.

You are correct when it goes to $20: one way you make $10 in profit; the other way you make $8.

The other difference is that if the price doesn't go up fast enough you will never exercise the option even if stock goes up a few days after the deadline.

If the goal is not to hold shares for the long term, then the question is how often are you wrong? How often do you have to be right to make buying the call option the right move.

Answer 3

Yes if you had bought the stock for $10 you would have made $10 instead of $8 by buying a $2 option, but you miss a few details:

• With the option you only risked $2 - if you bought the stock and the company went bankrupt you'd have lost all $10.

• You could have bought 5 options for the same $10, then your profits would have been $40 instead of $10.

That's where the concept of leverage comes into play - you multiply the relative return, or the total return if you invest the same amount.

Leverage multiplies returns in both directions. Yes, in your scenario you made a much higher relative return, but if the stock had gone down, you would have lost all $10. So the downside risk is multiplied as well.

Yes you can make higher returns with options because of leverage, but you can also have higher losses. If you don't know what you're doing (and don't use proper risk management), you can end up taking massive losses without much effort.

Answer 4

Assuming no margin, to trade a stock, you must have the enough money in your account for the shares. A call option controls the same number of shares for a fraction of that amount. While the shares will make more than the buying one call if share price increases significantly, the return on investment is higher for the call. That's the first level of leverage.

The next level of leverage is buying all the calls that you can with the same dollar investment as buying the shares. Now you're supercharged for potential profit.

It's important to note that an option is a decaying instrument and if share price does not rise, you are much more likely to lose some or all of your principal than with the shares.

Answer 5

While stock trading can yield profits, call options possess greater profit potential due to their ability to amplify gains. With a well-executed options strategy, investors can leverage the power of stock price movements and generate substantial returns.

Answer 6

Because you sell the option. If GME (underlying) is trading at $20, the option would likely be selling for $12.50 (low guesstimate). So you would profit $10.50 vs exercising the option and turning it around to sell for a profit of $10.

Edit: guesstimate because no information is given on IV or any of the greeks, particularly theta.

Edit2: on second thought, if you are paying $2 ($0.02) for an option atm, there is likely not much theta left. So this question doesn't make sense.

Edit3: if the underlying doubles, the option price will more than double. That's the answer.