Kevin Matras shows how to nearly mimic the underlying stock with half the amount invested.

One of the benefits of options is their leverage.

But in today's piece I'm going to refer to it as 'efficiency'.

And the best way for me to illustrate what I mean is to give an example.

So...

Let's use a stock like Apple (AAPL - Analyst Report).

Stock

As of the close of business on Wednesday, Jan 27, AAPL was trading at approximately $207; so to buy 100 shares, it would cost you roughly $20,700.

For every $1 price move in AAPL, your position would change in value by $100.

If AAPL moves up $20 (or nearly 10%) your investment would be up $2,000.

Pretty good.

Now let's look at an option.

Option

Our goal with this strategy is to try and mimic as close as we can the same profit gain without taking on substantially different risk (aside from the obvious fact that one's a stock and one's an option).

Let's also say we want enough time to stay in while Apple rolls out their new iPad (you know, actually starts selling it) and we get an idea of their sales -- so I'm selecting the July options with roughly 6 months of time on it.

The 110 Call is going for 100 or $10,000.

With Apple at $207, the 110 call is $97 in-the-money, which means your option literally has only $300 of time value.

And since this option is so deep-in-the-money, it has a delta of .98, which means it'll move 98 cents for every $1 the stock moves. In other words it has a delta of 98%.

So...if Apple moved up $20, your option would've increased by 98% of that, which is $19.60 or $1,960.

That's almost identical to the stock's gains.

And if it happened quickly, there'd be virtually no time loss or time decay, so your option would now be would worth $11,960. That means it would have produced a profit of $1,960 and you could sell your option immediately and take your gains.

With this illustration, you made almost the same amount of profit ($1,960 vs. $2,000) but on literally less than half as much invested.

How's that for efficiency?

And if it took the entire 6 months to make that move -- so what?

Apple would now be at $227.

And $227 less your strike price of $110 = $117.

That $117 (or $11,700) is what your option is worth. All you gave up was that $300 in time value at expiration. So that's a $1,700 gain.

And a $1,700 gain in the option vs. a $2,000 gain on the stock - on less than half the cost of investment - is still phenomenal.

In fact, since we are talking efficiency, not only did we nearly mimic the absolute dollar return in both of the examples, but based on a percentage gain in relation to your investment - the options, based on the above examples, produced a return of 17% to over 19.5% on money invested while the stock return was 'only' 10%.

That's virtually the same amount of money, but doing it on half the investment with nearly the same stock risk in that price range.

What about the downside?

On the downside, your option is basically losing the same amount as the stock for every dollar decline that's seen.

And at expiration your option has essentially mimicked the stock's price, plus the lost time value, which in this example is an extra $300.

The only real major difference in risk in this example lies with stock ownership if you're absolutely dead wrong on the stock.

For example, if Apple were to drop $97 all the way down to your strike price of $110, your option would have no time value left and no intrinsic value either, which means you would have lost the entire $10,000 that you paid for the option.

The stock guy would've lost virtually the same as well, i.e., -$9,700.

And actually, if it fell even more, the stock guy would keep on losing money while the option guy would not.

But, at expiration, the stock guy still has his stock. The option guy is done.

If Apple immediately shot back up to $207 for instance, the stock guy is back to even. The option guy still lost.

Of course, you could always buy another option if you're still bullish on the stock, but as far as this example goes, that's the only real difference in risk, aside from the time value part.

A lot of people don't look at deep-in-the-money options. But if you did, you’d see the extraordinary benefits to it.

You can learn more about different types of option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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