Compound Option

Adventurous investors don’t just buy stocks—they like to guess which direction the market is heading while still trying to cover their bets.

One way to accomplish this is to buy options, which are also known as a type of derivative. A call option is when you think the price of a stock is going to go up, while a put option is used when you think the price will be going down. With a compound option, the investor is able to “ride” a stock (extend the life) without investing as much money as would be required to buy the stock outright at the current time. Compound options are not risk-free, and they also involve paying a “back fee.”

Here’s how it works:

Charlie is feeling bullish about the current market and, in particular, has been following Optional Compound Inc. So he buys a call option to purchase 200 shares at $50 a share...not today, but six months from now. And he's buying the call option from a seller of that option...kind of like an option to purchase an option. (This is where the compound name comes in). Charlie pays the seller $2,000 for that call option.

So six months roll by, and Charlie decides to exercise the call on the option. In addition to paying for the stock, he has to pay the premium on the second option, buying the 200 shares at $50 per share. This is the back fee; Charlie has to pay $7,800.

It’s best to consult a professional before trying this at home, but compound options can be very useful...if you don’t mind paying a back fee.