"MORE INDEX!" - Stocks versus Options

The COVID break is over! We have a full recovery plus some and NOW what do we do?. Obviously, just buy and hold MORE INDEX. Or to paraphrase: "More Cowbell!" 

In my view, once the ECONOMY recovers, which it WILL, the market will roar and maybe return to Obama level gains. (Note Obama markets doubled in the first term and rose 50% in the second also GDP growth outpaced the pre-COVID Trump era).

Given this bullish opinion, this post will compare the returns from buying the stock to the equivalent buying of TWO "at-the-money" call options. 

A valid test is time period neutral, no cherry picking. Year-to-date 2020, with an extreme decline and extreme recovery plus some, is a perfect stress test for nearly every scenario. A valid test would also use the largest most liquid tradeable index and options available, the S&P500 ETF SPYs!

In options speak, one "at the money" (atm) call option is equal to 50 shares of the underlying stock. Thus 2 atm SPY calls = 100 SPY. See a more complete discussion of options here.

The closing price of SPY on the last day of 2019 was $321.86. The "full year", atm call on that date was the 18 December 2020 expiration, $322 strike, call option. The comparison of buying 100 SPY versus buying 2 SPY atm calls is shown below:

Quotes Source: Thinkorwim Thinkback

The options cost roughly $4,000, a fraction of  the more than $30,000 needed to control 100 shares of SPY.  Likewise the return on investment is huge for the options, while the dollar gains are roughly the same. 

A small caveat is that while you must pay for the options up front in full; the stock position may require one half to a third of total cost depending upon your broker's margin requirements. Thus the return on investment, ROI, would be much larger for the stock position but still far below that of the options. 

A large caveat is that options expire, stocks don't! If the stock is not up enough, you will lose ALL or some of your atm option investment. When your time runs out, your option expires. You stock doesn't expire. 

A final caveat, this is just one data point, just one year. While the method is valid, there is no guarantee that any given year will produce the same results. Consider 2017 for a counter example. 

In conclusion, options may be one of the best ways to capture stock market gains in rising markets.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.