Options Democratize the Stock Market

What do I mean by that rather arresting phrase? Simply phrased, options make it possible for investors of even modest means to invest in a stock that they think will move higher (or lower) within a 12-15 month  time frame.

Let's look at Apple (AAPL). At this writing (9:00 CDT) the stock is moving higher and trading at 504.50. That may seem high, but even at that price the stock has a relatively modest price/earnings ratio of 12.60 compared to 17.81 for the entire S&P 500 and 20.35 for the NASDAQ 100.

However, the price of the stock means that buying just 100 shares costs $50,450 which is a lot of money for all but the very affluent. An alternative would be to purchase a long dated vertical call spread.

Let's look at the January 2015 510-710 call spread. This spread can be bought today for 47, or $4700 for each spread. That $4700 is also the most money that can be lost if AAPL is lower than 510 in January 2015. However, at 710 or above (don't forget, just last November the stock was 705) the spread is worth 200 which means that you quadruple your money. You could simply buy the 510 call for 64.50 and have potentially unlimited upside potential, but I find it more prudent to use a vertical spread because of the lower cost.

One disadvantage is that as an option owner and not a stockholder you do not get any dividends. But, AAPl has modest dividend yield of only 2.44%, so you're not giving up very much.

Let's take a bearish example. Take Priceline (PCLN), for instance. If you think (as I do) that the stock trading now at 964.81 is way too high, given it's iinflated price earnings ratio of 31.77, you can purchase a long dated vertical put spread. Most investors have no way of selling PCLN short unless their account is very large. But options give anyone with even modest means the ability to profit from a decline in PCLN.

The January 2015 850-650 vertical put spread can be bought at 50, or $5000 per spread. Keep in mind that less than one year ago PCLN was trading at 550. A close below 650 on January 2015 means the spread is worth 200, or 4 times what you paid for it.

So, you can see that options democratize the stock market by allowing anyone of even simple means to profit from any long term view of a stock that they may have.