Investing with options - Microsoft: comparing stock purchases with options strategies in a $15,000 investment simulation

Important disclaimer: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.

Our investment strategy analysis for Microsoft (MSFT) starts from a bullish perspective, with an anticipation of price growth over the next year. The chart outlines three price levels—$500, $400, and $300—to explore how the investment strategies we discuss may unfold if the stock diverges from this initial optimistic projection:

• A rise to the $500 target is the most favorable outcome of our bullish scenario, suggesting a significant upward trend for Microsoft.
• A holding at the $400 target represents a less dynamic market, where MSFT maintains its value near the current level, an outcome that could still be favorable depending on the chosen investment strategy.
• A drop to the $300 target provides a contrasting view, where despite our bullish outlook, the strategies' resilience to a decline can be assessed.

These price points are not predictions but reference markers for strategy performance under various market movements. They help frame our analysis within a context of optimistic intent, allowing us to measure the impact of changes against our initial positive expectation. Should our starting premise have been bearish, our focus would shift to strategies that capitalize on or protect against a decline.

Direct stock purchase: the foundational investment in Microsoft

Directly purchasing Microsoft (MSFT) stock is a straightforward investment approach, providing ownership in one of the world's leading tech companies. At $403 per share, a $15,000 budget would allow you to own 37 shares, directly tying your investment to the company's market performance.

Pros of Direct Stock Purchase:

• Simplicity: Buying stock is a clear, direct way to invest.
• Dividends: Potential for regular income through dividend payouts.
• Voting rights: Ownership includes a say in company decisions.
• Longevity: No expiration; ownership lasts as long as the company exists.
• Capital growth: Share value can appreciate over time.

Cons of Direct Stock Purchase:

• Capital risk: Full investment at risk if the stock value declines.
• Lack of diversification: A large amount tied up in a single asset.
• Limited enhancement strategies: With only 37 shares, you can't write covered calls, a strategy needing at least 100 shares to execute, which could otherwise optimize returns.

Considering our bullish baseline and the three scenarios for MSFT's future price:

• At a $500 target, a 24% stock rise would increase your holdings' value to about $18,500.
• If MSFT remains near $400, the investment would slightly dip to $14,800.
• A drop to $300 would reduce the investment's worth to roughly $11,100.

When the market takes an unfavorable turn, investors often fall into the psychological trap of becoming 'married' to their stock, holding declining positions in the belief of a rebound. This hope-driven approach can lead to 'holding positions into eternity' when the stock goes south, often amplifying losses instead of mitigating them. It's a common pitfall that underscores the importance of having a disciplined exit strategy.

In the subsequent sections, we will explore how options strategies can provide alternative avenues for investing the same $15,000, offering varied risk-reward profiles that may align with different investment goals and market perspectives.

Long calls: leveraging your Microsoft investment

The long call options strategy offers a nuanced way to leverage a $15,000 investment in Microsoft (MSFT). Opting for long call options with a strike price of $375 when the stock is at $403, and with a premium of $64.10 per option, the total cost for 2 contracts amounts to $12,820. The remaining $2,180 can be used to purchase additional MSFT shares.

Pros of long call options:

• Effective leverage: 2 long call options control the equivalent of 200 shares, providing substantial market exposure.
• Enhanced return potential: Allows for strategies like covered calls, potentially enhancing annual returns.
• Capped risk: The maximum loss is limited to the premium paid.
• Flexibility in execution: Options can often be sold for profit without exercising, avoiding extra transaction costs or taxes.

Cons of long call options:

• Premium cost: Substantial initial investment required for the option premium.
• Time decay: The value of options may decrease as expiration approaches if they are not in-the-money.
• Higher break-even point: The stock price must exceed $439.10 (strike price plus premium) for the options to be profitable, not accounting for the extra shares bought.

Considering our bullish baseline and the potential scenarios for MSFT's future price:

Scenario 1: MSFT reaches the $500 target

• Total profit for 2 options: $12,180 (2 options times ($125 intrinsic value - $64.10 premium) times 100)
• Profit from additional shares: $485 (5 shares times ($500 - $403 stock price increase))
• Total profit: $12,665 ($12,180 from options + $485 from additional shares)

Scenario 2: MSFT remains at the $400 target

• Total loss for 2 options: -$7,820 (2 options times ($25 intrinsic value - $64.10 premium) times 100)
• Loss from additional shares: -$15 (5 shares times ($400 - $403 stock price decrease))
• Total loss: -$7,835 (-$7,820 from options - $15 from additional shares)

Scenario 3: MSFT drops to the $300 target

• Total loss for options: -$12,820 (2 options times $64.10 premium times 100)
• Loss from additional shares: -$515 (5 shares times ($300 - $403 stock price decrease))
• Total loss: -$13,335 (-$12,820 from options - $515 from additional shares)

Long calls offer a compelling avenue for those bullish on MSFT, using leverage to amplify potential returns while keeping risk limited to the premium paid. The capability to control the equivalent of 200 shares not only offers leverage but also opens the door to advanced strategies like covered calls for extra income. In profitable scenarios, selling the options in the market is often preferred to avoid additional transaction costs and complexities associated with exercising, highlighting the strategy's practical flexibility.

Next, we'll explore the long call zebra strategy, presenting an alternative approach with unique considerations and financial implications.

Long call zebra: mirroring stock movements with precision

The long call zebra strategy is a sophisticated approach, finely mirroring the movements of Microsoft (MSFT) stock with precision and less capital. By buying in-the-money calls with a strike price of $345 and selling calls with a strike price of $405, you create a position that closely tracks MSFT's price movements, with the total investment in the zebra position being $12,380, leaving $2,620 for additional stock purchases.

Pros of long call zebra:

• Stock-like movement: Emulates stock price movements almost dollar-for-dollar.
• Lower breakeven: The breakeven point is closer to the current stock price compared to standard long calls.
• Reduced theta decay: Selling a call offsets the time decay associated with long calls, helping maintain the position's value over time.
• Capped downside risk: The maximum loss is limited to the net premium paid.

Cons of long call zebra:

• Complexity: Requires careful management and understanding of strike price selection.

Let's revisit the potential scenarios based on our bullish outset and the long call zebra strategy:

Scenario 1: MSFT reaches the $500 target

• Gain from long calls: (500 - 345) times 100 times 2 contract = $31,000
• Loss from sold call: (500 - 405) times 100 times 1 contract = $9,500
• Net gain from zebra: $31,000 - $9,500 - $12,380 (zebra cost) =$9,120
• Profit from additional shares: (500 - 403) times 6 shares = $582 (6 shares = 15,000 - 12,380 = 2,620 divided by 403/share and rounded)
• Total profit: $9,120 + $582 =$9,702

Scenario 2: MSFT remains at the $400 target

• Gain from long calls: (400 - 345) times 100 times 1 contract = $5,500
• Loss from sold call: $0 (the sold call expires worthless)
• Net gain/loss from zebra: $5,500 - $12,380 (zebra cost) = -$6,880
• Profit/loss from additional shares: (400 - 403) times 6 shares = -$18
• Total loss: -$6,880 - $18 = -$6,898

Scenario 3: MSFT drops to the $300 target

• Total loss for zebra: -$12,380 (net premium paid for zebra)
• Loss from additional shares: (300 - 403) times 6 shares = -$618
• Total loss: -$12,380 - $618 = -$12,998

The long call zebra strategy offers an innovative way to engage with the bullish outlook on MSFT, closely simulating stock movements with a reduced capital requirement and a lower breakeven point compared to simple long calls. Its structure, which includes selling a call, significantly reduces the impact of time decay, offering a unique alternative for investors. Despite its complexity, the strategy provides distinct benefits, making it an attractive option among the various investment strategies.

Next, we'll compare the different strategies, highlighting their unique advantages and potential under varying market scenarios.

Comparing investment strategies: direct stock purchase vs. long calls vs. long call zebra

When considering an investment in Microsoft (MSFT), the choice between direct stock purchase, long calls, and the long call zebra strategy depends on your investment goals, risk tolerance, and market outlook. Here's a detailed comparison highlighting the unique advantages, potential, and considerations of each strategy based on our bullish outset:

Direct stock purchase:

• Pros: Simplicity, dividends, voting rights, potential for long-term capital growth.
• Cons: Significant capital at risk, lack of diversification, inability to employ certain enhancement strategies due to the limited number of shares.
• Performance in scenarios:
  • At $500: High capital growth, shares worth $18,500.
  • At $400: Slight decrease, shares worth $14,800.
  • At $300: Notable decrease, shares worth $11,100.

Long calls:

• Pros: Leverage allowing control over more shares, capped risk at the premium paid, potential for enhanced returns through strategies like covered calls.
• Cons: High premium cost, time decay affecting option value, relatively high break-even point ($439.10).
• Performance in scenarios:
  • At $500: High profit potential, total profit of $12,665 (on top of the $15,000 investment).
  • At $400: Potential loss if stock doesn't exceed break-even, total loss of -$7,835.
  • At $300: Limited loss to the premium paid, total loss of -$13,335.

Long call zebra:

• Pros: Stock-like movement with less capital, lower breakeven than long calls, reduced theta decay, capped downside risk.
• Cons: Complexity in execution, capped upside due to the sold call.
• Performance in scenarios:
  • At $500: Profits akin to stock holding, total profit of $9,702 (on top of the $15,000 investment).
  • At $400: Reduced loss compared to long calls, total loss of -$6,898.
  • At $300: Loss capped at the net premium paid and additional shares, total loss of -$12,998.

In essence, direct stock purchase offers a straightforward, long-term investment approach but lacks the leverage and risk mitigation strategies that options provide. Long calls introduce leverage and a risk-restricted way to capitalize on bullish movements but come with the caveat of premium costs and time decay. The long call zebra strategy affords a balance, closely emulating stock movements with lower capital and reduced time decay, though it requires careful strike selection and management.

Your choice among these strategies should align with your market perspective, risk appetite, and investment objectives. Each offers unique advantages and comes with its own set of considerations, making it crucial to understand their dynamics thoroughly before committing capital.

In the end, whether you opt for the solid ground of direct stock ownership, the leveraged play of long calls, or the precision of the long call zebra, your strategy should be a reflection of your market view, financial goals, and the degree of active management you're willing to commit.

Conclusion

Our exploration of investment strategies in Microsoft reveals a spectrum of choices, each with its distinct character and potential. Direct stock purchase is the cornerstone of traditional investing, offering stability and long-term growth. Long calls add leverage and the possibility for significant returns, ideal for the bullish and the bold. The long call zebra strategy offers a balance, closely emulating stock movements with controlled risk, suitable for those seeking a measured approach.

Does this mean you should pivot entirely to options, or reshape your entire portfolio around them? Not necessarily. The beauty of investment lies in its flexibility. You might choose a hybrid approach, combining the tangibility of direct stock with the strategic potential of options. This blend allows you to tailor your investment to your comfort level, financial goals, and market outlook.

As you chart your course through the waters of investment, remember: informed decisions, underpinned by knowledge and adaptability, are your most valuable compass. Whether you find solace in the stability of direct stock ownership, the thrill of leverage through long calls, or the precision of the long call zebra, ensure that your strategy is a harmonious extension of your investment philosophy.

Invest wisely, stay adaptable, and let your choices reflect your financial aspirations, with the flexibility to navigate as you see fit. After all, the journey of investing is not just about reaching a destination; it's about finding your path and walking it with confidence and insight.

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