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Writer's pictureKevin Parker

Should I buy Shares or Options/Spreads?

This was a question a friend asked me earlier today. It is an important question, and the answer is not straight forward. It will not be, "Options are better every time" or "Always buy shares when...", the choice requires more thought than that and we will breakdown one example below.


My friend said that he has $1500 in his account for opening tomorrow morning, and is interested in buying into GrowGeneration (GRWG). This company is involved in every aspect of the Cannabis industry from horticulture to lighting, to brick-and-mortar stores (31 as of December 5th, 2020). I believe Cannabis is going to be a huge winner with a Democratic Presidency. I believe we will see leniency in laws, and legalization nationwide within the first year of Biden's Presidency, which would be huge for these companies who are just waiting to grow (Literally and Figuratively).


So what? Should I buy Shares or Options? - Let's break it down by the numbers.


Shares

If my friend decides to buy shares in GRWG, he will buy approximately 30 shares. We are rounding here for simplicity sake, $1500 divided by $50 a share equals 30 (1500 / 50 = 30). He believes this sector has a lot of room for growth, and he thinks shares of GWRG will be $75 by the end of next year.


His Shares would now be worth $2,250, his 30 shares at $75 each, 30 x $75 = $2250


That is a net gain of $750 on this trade over 1 year ($2,250 - $1,500 = $750), which isn't all that bad at 50% gains.


Bull Call Debit Spread Option

The next piece to consider is the price of the options. Remember, I always try to go far out, the further the better when I am buying Calls and Bull Call Spreads. I flipped over to the Jan 21, 2022 options and saw that they were super expensive, in my opinion. To buy a $60 Call, you'll be paying about $15.53 ($15.53 x 100 = $1553) per contract. When calls are this expensive, it is because the majority of people agree with you, they also think shares in GRWG will be over $60 by Jan 2022. For me, this is not investable as a call option alone, it is just too expensive, plus that would be my friend's entire $1500 budget.


My next thought, when options are this expensive, is to look if a Bull Call Debit Spread would be worthwhile. If you haven't read about Bull Call Debit Spreads, give that a quick read first, and then finish this so it makes more sense.


When buying Bull Call Debit Spreads, you want as wide of a spread as possible, so I am going to Sell a $75 Call, which is currently $12.03 ($12.03 x 100 = $1203) per contract. This gives me a spread of $15, The Buy at $60 and the Sell at $75 (75 - 60 = 15), that is your profit window. In the simplest terms, this spread is saying that you are happy to buy shares of GRWG for $60, but you are also more than happy to sell them at $75 a share. This is what creates your loop so you do not ever need to own shares in the company, you are just buying and selling the option to buy and sell them at certain prices (Strike price), by a certain date (Expiration Date). Always Buy the lower Strike Price, and Sell the higher Strike Price.


The Trade - After hitting "Select" in the top corner:

Buying the $60 Call: Paying Approximately $1553

Selling the $75 Call: *Being Paid Approximately $1203

The Total Cost (Maximum Loss): $1553 - $1203 = $350

It may ask if you are "Expecting a Credit or a Debit on this trade?" and you will select "Debit." Debit means you are paying more for the lower strike price than the lower, a credit would be if you were being paid a net gain on the trade. That won't happen with Bull Call Debit Spreads, it will always be a Debit. When you go to close (sell) the spread, make sure you sell the spread as a complete unit again. You can buy/sell the pieces individually, but that can get messy, so avoid it until you understand everything.


If GRWG does what my friend expects, and it is $75 on January 21, 2022, then the spread that you own will no be worth approximately:


You own the 1 Call Option to buy 100 shares of GRWG at $60 a share, for an approximate option price of $1500 ($15.00 x 100 = $1500). That number is determined by the share price ($75) minus the strike price ($60), 75 - 60 = 15. Each dollar ($1) over your strike price, you gain approximately $100 in value, this is especially true when options are expiring, it can be more volatile if the option is further from the current date.


You also Sold 1 Call Option for $75, meaning if GRWG goes over $75 a share, you are on the hook for 100 shares at $75 per share. But that is okay, because we have the option above to buy them at $60, netting us the $15 profit, if GRWG was to surpass $75 a share.


This would be our maximum profit point. Our Buying and Selling loop starts at $60 with our buy, and ends at $75 with out sell. On expiration, if GRWG closes at $74.99 I would keep the approximate $1500 from the Buy Option, and the Call option is now worthless, meaning the $1203 you were originally paid is your to keep.


Now keep in mind, if GRWG shoots up to $78 per share, a month after you bought the spread contract and you still have 10 months until expiration, you've already reached max profit and can just probably sell the spreads for nearly $1500 each (the difference between $60 and $75 for 100 shares ($7500 - $6000 = $1500). It would be up to you what price you'd want to sell the spread at to get filled, it may take a little less total profit, but I usually just slowly drop my price until it fills.


This Options Spread would cost me $350 to open, with the maximum profit of approximately $1500 if the shares in the company reached $75.


Potential Gains and Final Thoughts

If GRWG was to grow to $75 a share at some point over the next year:


Shares - $1500 investment, unlimited time, $750 unrealized profit at $75 a share.

Bull Call Debit Spreads - $350 per spread, 1 year of time, $1500 maximum profit per spread. My friend could potentially buy 4 spreads for $1400 and have maximum profit potential of nearly $6000, plus and extra $100 for something else.


The downside of Option Spreads is time, just like calls, if GRWG goes down or stays the same over the next year, you will watch your $350 investment slowly deplete to $0. Whereas holding the shares, you just keep going with the market, they won't go to $0 unless the company dies. This is why buying long-term is the best way that I have found, I give the company time to grow and also time if something, like coronavirus happens, and you need the time to recover.


Your risk tolerance and faith in a companies growth should determine what you choose, I'd just advise you to not be afraid to try a spread.


Let me know what you think!


Thank you,


Kevin Parker

Retail Trader

Dreamer of Financial Freedom


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