Call option volume in Goldman Sachs (GS) on Tuesday outpaced put volume by a ratio of 2-to-1, which could be seen as a bullish sign.
Goldman Sachs stock also bounced at the rising 50-day exponential moving average.
Goldman Sachs Stock Option Trade
Traders thinking the rally in GS stock will resume shortly can look at buying call options as a speculative play.
A call option is a contract between a buyer and seller. The contract gives the buyer the right to purchase a certain stock at a certain price (strike price) up until a certain date (expiration date).
One of the benefits of call options is that they provide leverage (this can be both good and bad).
Assuming an investor wanted to buy 100 shares of Goldman Sachs stock, they would have to invest around $37,000 at the current price.
Instead, the investor could gain a similar exposure using a fraction of the capital by buying a call option.
One call option gives the investor exposure to 100 shares.
If an investor were to buy one 350 call option for Goldman Sachs stock expiring in October, they would only need to invest around $3,100 rather than $37,000. If Goldman Sachs stock goes to $0, the investor loses only $3,100 while still maintaining a similar exposure to the gains.
The GS 350 call option gives the investor the right to buy 100 GS shares at 350 up until the expiration date.
The call option costs around $31, so the investor would need Goldman Sachs stock to rise above 381 (strike price plus premium paid) to be profitable on the investment.
There is always a risk with trading on leverage like this, of course, and if Goldman Sachs stock drops below 350 at expiry, the investor will lose 100% of the investment, which is $3,100. An investor holding 100 shares, on the other hand, would lose around $2,000.
Savvy traders might consider reducing the cost of the long call by also selling an out-of-the-money call. This reduces the cost but also reduces the gain potential.
For example, the October 410 strike call for Goldman Sachs stock can be sold for around $5.90, reducing the cost of the long call by $590, but would cap any gains above 410.
Long call options and bull call spreads can be a great way to gain exposure to a stock without risking as much capital as would be required to buy the stock outright.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
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Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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