Cut Your Risk With Call Options

The Citigroup January at-the-money $37.50 call can be bought for $2.50, or $250 per contract with each contract representing 100 shares. If the shares increase another 20% to $45 by year-end (but remember, calls don't expire until the third Friday of the contract month; in this case, that's Jan. 18, 2003), the calls, according to my unscientific calculation, will be worth $8. Despite being in the money, they will still be awarded some time premium due to the three weeks remaining until expiration.

That's a 220% gain, or a profit of $550 per contract. Owning 100 shares would have yielded a $750 gain, but bear in mind the risk was $3,750, significantly greater than the $250 cost of the call. Even using margin, you would have had to put up $1,875 for the stock.

Dealing With Uncertainty

The point is that call-buying in the near term is a great way to maintain or start building an investment in stocks. If in the next few months accounting issues subside, earnings stabilize, the Iraqi picture clarifies and the October lows hold, you can feel more confident buying stocks and funds outright.

One issue that should be addressed is your brokerage account and how you place orders. Namely, are the commissions cost-competitive and does the system allow you to execute the desired transactions? Most online brokers permit anyone to purchase option contracts, provided they possess a minimal amount of monetary and mental capacity.

But complications can arise in selling or shorting options. Many online brokers won't execute a short option sale, even if it's offsetting a long or creating a covered position against a long stock. Provisions need to be made with your representative and orders may need to be submitted verbally.

Some firms such as Schwab (SCH) and Brown Trading offer spreading, combo and multistrike option orders as part of an online trading package. Systems catering to professionals, such as InterActiveBrokers, also accommodate options traders.

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