Building a Better High-Multiple Portfolio

Since at-the-money calls all have a delta of about 50, it's expected that every $1 change in the price of the stock will result in a 50-cent change in the option's value. In this way, the value of the options portfolio will fluctuate less and have a lower volatility than the underlying share price. Remember that an option's delta changes along with the price of the stock -- as the call moves further into the money, its delta, and the position's long exposure, also increases.

Typically, when determining the amount of options to buy, it's usually suggested to base your decision on share count rather than dollar amount. Just because you might have been willing to spend $2,500 to buy 100 shares of XYZ Corp. at $50 doesn't mean you should buy 25 of its call options at $1, or $100 a contract. The table below is an illustration of matching share count to reduce the initial capital outlay and overall risk.

But assume that you have $10,000 of risk capital and want to invest it equally among the four stocks ($2,500 each) mentioned above. The table below shows the number of underlying shares (again assuming a 50% margin requirement) and the number of call options that could be purchased for $2,500 at current prices. It also compares the profit and loss of each position based on the stock price moving 15% higher or lower over the next two months.

Note that allocating capital to options on an equal dollar-amount basis will result in potentially larger losses and profits due to the increased leverage of options. Also, it's important to keep in mind that if the stock prices remain unchanged, the options portfolio would incur a loss resulting from time decay. In this case, the value of our holdings on Sept. 20 will have declined by about $2,200, or 22% of the initial $10,000 investment.

What You Can Buy With $10,000			Values and P/L for Stock		Values and P/L Options
Company	No. of Shares	No. of Calls	15% Decline	15% Increase	15% Decline	15% Increase
EBAY	63	3	$68 ($744)	$92/ $744	$1.67/ ($1,959)	$15/ $2040
BRCM	134	5	31.67/ (774)	42.8/ 774	1.50/ (1,750)	7.70/ 1,100
QCOM	71	4	59/ (738)	80/ 738	1.10/ (2,160)	12.50/ 2,400
YHOO	170	7	25/ (749)	33.80/ 749	1.00/ (1,800)	5.80/ 1,540
Net Cost P/L	10,000	$10,000	($3,005)	$3,005	($7,600)	$7,800
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