Options Forum: Never Rich Enough

Addressing the second part of the first reader's question, he is correct in being surprised that despite a steep decline in KLAC -- which has a current implied volatility of 40 for at-the-money strikes, and was near a 52-week low -- volatility did not increase. How should one interpret that?

"They came, they saw, and they conquered KLAC," said Adam Warner, an options trader and contributor to Street Insight, a sister publication of TheStreet.com. "The stock is down roughly 10% so you'd expect the implied volatility to go higher. Yet volatility is hitting lows again in all time frames. So, here we have a stock that's made a huge move up this year with legitimately bearish news and it's met with option selling. That's complacency."

Skinning Cats and Balancing Acts

Another reader asks:

Which is a better way of buying upside exposure while limiting downside risk: (1) buying one call contract, or (2) buying 100 shares of the underlying stock with a stop that limits your loss to the cost of the call? Is one strategy always better than the other, or does it depend on the situation and your objective?

--U.V. .

This is related to the first reader's frustration of not reaping what he thought he had sowed. Would there have been an alternative position that better aligned with predicting reward expectations within the acceptable risk boundaries?

There is no simple way to answer that without knowing all variables and then inputting various scenarios into a number of positions.

Sticking with the example above, shorting 100 shares of KLAC at $60 and covering it at $53.30 would have produced a $670 profit, or a 22% return based on 50% margin. As we noted above, a purchase of the put would have produced a profit of only $400, but a return of nearly 115%. The other main difference is that the risk of the short stock is unlimited, while the maximum loss of the long put is limited to its purchase price.

The use of stops certainly can bring the risk levels into line, but the leverage of options will usually provide much greater return percentages. The real trick is choosing the right option, in terms of strike price and time remaining, that provides the best match and balance for your objectives. And for that, there is no single best answer.