Many investors, after entering the options market, do not utilize options effectively due to insufficient understanding and application skills. They merely regard options as speculative tools for making money. In reality, options can serve many purposes and assist investors in making better investment decisions. I plan to use several installments to explain how to leverage options effectively.

Today, I bring you the first installment, teaching you how to better utilize the operation of buying call options through some scenarios.

I. Using Call Options for Speculation

Scenario:

An investor has a principal of 500,000 yuan for investment and predicts that the price of a certain stock will rise significantly in the future. They buy 10,000 shares of the stock at a price of 50 yuan per share, costing a total of 500,000 yuan.

This scenario is a common operation for many stock traders. If the price rises to 60 yuan per share in the future, the investor will sell the stock and make a profit of 100,000 yuan. If the price falls to 40 yuan per share, the loss would also be 100,000 yuan.

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Now, let's assume the investor does not use the 500,000 yuan to buy stocks but instead chooses to buy call options for the stock after predicting a significant increase in the future.

Scenario 1:

The investor takes out 10,000 yuan from the principal of 500,000 yuan and buys 10,000 at-the-money call options with a strike price of 50 yuan per share at a price of 1 yuan per share, costing 10,000 yuan, with the remaining 490,000 yuan used for other purposes. If the stock price rises to 60 yuan per share in the future, the investor exercises the options, buying 10,000 shares worth 60 yuan at a price of 50 yuan each, making a profit of 90,000 yuan after deducting the option premium. If the price falls to 40 yuan per share, the investor does not exercise the options, and the loss is the entire option premium of 10,000 yuan.

Scenario 2: If the investor uses the entire 500,000 yuan to buy the aforementioned call options, and the price rises to 60 yuan per share, the investor can exercise the options to buy 500,000 shares worth 60 yuan at a price of 50 yuan each, making a profit of 4.5 million yuan after deducting the option premium. If the price falls, the loss is the entire option premium of 500,000 yuan.Through the two scenarios mentioned above, we can discern the difference between purchasing a call option and simply holding the stock. Purchasing a call option can provide a high leverage effect, requiring less capital to hold the same number of shares, or alternatively, allowing for holding more assets with the same amount of capital. Moreover, unlike futures, there is no need to pay a margin when buying options, thus exerting less pressure on funds.

However, there are also drawbacks to buying options. Similar to futures, options cannot be held for a long time and must be decided whether to exercise or hedge before expiration. Therefore, investors need to choose a reasonable expiration time and strike price before purchasing call options, and select an appropriate position size based on their risk tolerance. Additionally, the cost of the premium paid for the option should also be considered.

II. Limiting the Risk of Selling the Underlying Asset

Strategy: Sell the underlying asset while buying a call option on that asset.

Scenario 1:

A corn dealer has a batch of corn inventory. The current market price is 2800 yuan/ton, which meets the dealer's expected price. At the same time, the dealer believes that the corn price trend is unclear and cannot make an accurate prediction. After much hesitation, the dealer decides to sell the corn at a price of 2800 yuan/ton.

Scenario 2:

An investor buys a stock index stock at a price of 17 yuan and holds it for a while. The price rises to 20 yuan, and the investor believes that the future price trend of the stock is uncertain. Therefore, the investor chooses to sell the stock, earning a profit of 3 yuan per share.

In the above scenarios, investors believe that the price trend of the assets is unclear, so they sell their assets. If the price falls afterward, they avoid the loss caused by the price drop, but at the same time, they also lose the potential for greater gains if the price continues to rise. If they buy a call option while selling the asset, they can hedge against a certain degree of price risk while retaining the possibility of gains from a continued price increase.

Let's see what difference it would make if investors choose to buy a call option while selling the asset.Scenario 1:

After selling corn at a price of 2800 yuan, the corn dealer immediately purchased a call option on corn with a price of 20 yuan and an exercise price of 2800 yuan (at-the-money option). If the price falls in the future, the loss will be limited to the premium paid, effectively locking in a minimum selling price for the corn at 2780 yuan (if the spot price is below 2780 yuan at that time, the dealer still makes a profit). If the price rises in the future, the higher the increase, the greater the option's profit, and thus the higher the actual selling price of the corn.

Scenario 2:

After selling stocks, an investor secures a fixed profit of 3 yuan per share and simultaneously purchases a call option with a price of 0.5 yuan and an exercise price of 20 yuan. If the stock price falls afterward, the investor only loses the premium, resulting in a net profit of 2.5 yuan per share, thus avoiding the scenario of incurring losses due to a price drop. However, if the stock price continues to rise, the higher the increase, the greater the profit. This method locks in a minimum profit of 2.5 yuan per share while retaining the potential to profit further if the stock price continues to rise.

Through these two scenarios, it is evident that when the price of the underlying asset is uncertain, selling the asset and simultaneously purchasing a call option can lock in a minimum selling price equal to the current selling price of the asset minus the premium paid, while also retaining the potential to profit from future price increases.

This strategy is generally used when the trend of asset prices is unclear. If an investor believes the trend of asset prices is clear, it is not advisable to use this strategy, as it would unnecessarily incur the cost of the option premium.

III. Hedging by Purchasing Call Options

Scenario:

A soybean oil mill will purchase a batch of soybeans in three months, with the current price of soybeans at 4000 yuan/ton. The mill anticipates that the price of soybeans may rise and, in order to reduce the cost of goods, it is compelled to purchase soybeans in advance, incurring a cost for inventory.

In the above scenario, the oil mill needs to purchase soybeans in three months but is concerned about a potential market price increase, leading to the decision to buy soybeans in advance. If the price rises as predicted, the mill will have paid extra for inventory costs. If the price falls, the mill will not only have paid extra for inventory costs but will also suffer losses due to the price drop. By choosing to purchase a call option, the mill can achieve the goal of locking in the cost of goods while also retaining the benefits of a price decrease.What are the benefits of replacing the purchase of soybean spot with a call option on soybeans?

Scenario:

A soybean oil mill decides to buy a call option on soybeans and limits its maximum purchase cost by choosing the strike price of the soybean call option. For example, the oil mill opts to purchase a soybean call option that expires in three months with a strike price of 4100 yuan/ton and a premium price of 100 yuan/ton. If the price rises, the oil mill can exercise the option to buy soybeans at the price of 4100 yuan; if the price falls, the oil mill can forgo the option and buy soybeans at the market price.

From the case, it can be seen that after the oil mill buys the call option, it is equivalent to using the option's strike price to set a maximum price for its future purchase plans, preventing losses caused by price increases. When the price falls, the oil mill can give up the option and buy soybeans at a lower price, thus locking in the oil mill's purchase cost three months later.

This strategy is generally used to hedge against the risk of asset price increases. Compared with buying futures to hedge risks, the advantage of options is that they have a greater leverage effect than futures, requiring less capital investment, and can avoid the risk of additional margin calls when prices move in an unfavorable direction. Compared with futures hedging, the disadvantage is that a premium must be paid, which increases the cost of hedging risk.