The deep in the money call strategy is one of the many strategies that I have been using since I started trading options and it's also one of the easiest to use when trading options. Whether you are new to options or experienced options trader this strategy provides a cheaper way to play stocks that offer options rather than buying shares. This strategy is usually referred to as a stock replacement strategy, since by owning a deep in the money call can make similar returns as if you owned underlying shares. For a look back at how I use the deep in the money strategy please click here and here.
I generally trade deep in the money options for two reasons. My first reason is that I tend to make deep in the money call option plays on blue chip companies that have positive fundamentals and have more room in their shares prices to head higher. This allows me to have ownership, but for a fraction of the price. If you follow me through Seeking Alpha stock talks, twitter or past articles you will notice some of the companies I trade options on are companies most people have heard of such as; General Electric (NYSE:GE), AT&T (NYSE:T) and Altria (NYSE:MO) for example. My second reason would be more for speculative purposes that I am bullish on. For example, if I was bullish on Silver (NYSEARCA:SLV) or Gold (NYSEARCA:GLD). Another example would be Lions gate (NYSE:LGF) and if one to make a speculative deep in the money call option bet before the "Hunger Games" news broke then you made a nice chunk of change. In the first reason I have provided, I stick to stocks that I am familiar with their price action, movement and technicals (just to name a few). In my second reason the stocks I tend to speculate in I am familiar with, but tend to trade every now and then.
Here is a list of companies I continue to follow and buy deep in the money calls on:
1) General Electric
To view my hypothetical portfolio, please check out my instablog to see how I traded some of these names. In the five names listed above I try to aim for a low breakeven point to profit and keep this breakeven to around a 1% movement in the stock price. Sometimes I get slack for taking profit early, but remember I am making option trades and not investments. An investment is something that you normally hold onto longer period of time than a trade. Options also have an expiration date and stocks don't. Here are some deep in the money calls I am considering.
Trade# 1: Buy Bank of America (NYSE:BAC) June 16 2012 $7 call
The bank stress tests proved to be an exciting catalyst for Bank of America and the stock soared over 20% since Bank of America sat at the $8 level. With the stress tests behind Bank of America, upcoming earnings could be what it takes for Bank of America to break through the $10 level since Bank of America has had some resistance with the $10 level.
Bank of America operates as a bank and a financial holding company that serves individuals, businesses and corporations. If investors like high beta trades, then Bank of America is right up your alley. Bank of America has a beta of 2.3 and on good days can deliver nice returns, but on down days you will have to stomach some volatility. Bank of America has upcoming earnings in the week of April 19,, 2012. I would want to play this trade up to earnings with the anticipation that Bank of America can break past the $10 level. However, I wouldn't want to hold on through earnings and I am only seeking to profit of Bank of America going higher into earnings. Bank of America only pays out an annual dividend of 0.04 cents or a 0.41% and I believe options are still an attractive way to play Bank of America instead of buying shares.
Trade Details: Buy Bank of America June 16 2012 $7 call
Cost of call= 2.95 or (2.95 x 100 = $295 per call)
Breakeven = strike price 7 + price of call 2.95 = $9.95 (9.95 - current stock price 9.84 = 0.11 cents to breakeven.
This 0.11 cents move is about a 1.2% move.
Delta on Bank of America $7 calls = 0.91
Days till expiration = 87
When technically looking at Bank of America investors will notice the stock is above the upper bollinger band (at the time I am writing this article). When stocks get above the upper bollinger band, it's only a matter of time before they will drift back inside the bollinger bands. I would want to wait to see if Bank of America gets inside the upper bollinger band and would be a buyer on pullbacks for a short term trade. By being patient, investors will be able to buy calls for cheaper as Bank of America is still cheap on a valuation basis.
Trade# 2: Buy Microsoft (NASDAQ:MSFT) May 19 2012 $28 call
Over the past couple of weeks the focus in the technology sector was mostly on Apple because of the recent IPad and dividend announcements. Despite some technology companies having to be in the shadows of the Apple news, technology as a whole as still been performing well. Over the past week Microsoft's stock has dropped a $1 or almost 3%. When looking at a chart of Microsoft, investors will notice the last time Microsoft was below the middle range of the bollinger bands was the beginning of the year. With Microsoft pulling back the last week, investors may be able take advantage of the pullback with this options trade.
Trade Details: Buy Microsoft June 16 2012 $28 call
Cost of call = 4.00 or (4.00 x 100 = $400)
Breakeven = Strike price 28 + cost of call 4.00 = $32.00 (32 - current stock price 31.83 = 0.17)
This 0.17 cents move is a little over ½ % needed to breakeven.
Delta = 0.84
Days till expiration = 86
In these two trades I would continue to monitor them and would wait for a pullback before jumping right in. Both of these stocks had a nice run since the start of the year and being patient could pay off. As always please do your homework and due diligence before making these option trades. Thank you for reading and good luck.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MSFT over the next 72 hours.