Can You Buy or Sell Call Options on Penny Stocks?
Not all penny stocks are created equal. In fact, the vast majority of them are essentially worthless, with many being at the mercy of fraudsters employing the pump and dump scheme. Understanding the mechanics of options, particularly call options, in this context can provide insights into how these fraudulent practices operate and why they should be avoided.
Understanding Call Options
A call option is a financial contract that gives the buyer the right, but not the obligation, to purchase the underlying stock or other security from the seller at a predetermined price, known as the strike price, by a specified expiration date. When the call option holder exercises this right to buy the stock, it means they believe the price of the stock will rise above the strike price by the expiration date. Conversely, if they fail to exercise the option, it lapses, resulting in a loss. This concept can be applied to any asset, including penny stocks, which create a powerful tool for investors seeking to profit from market fluctuations.
The Deceptive Nature of Penny Stocks and Call Options
Penny stocks are typically part of a risky investment landscape, especially for novice investors. They usually trade below $5 and are listed on secondary markets like the OTC market or Pink Sheets, making them difficult to research and understand. The allure of these stocks is often anchored in the misconception that they offer lucrative upside profits, which is frequently illusory.
Fraudsters often use the pump and dump scheme to manipulate the market. In such schemes, individuals or groups artificially inflate the price of a penny stock to attract buyers. Following this, the fraudsters sell off their shares at a high price, profiting handsomely before the stock's price collapses, leaving other investors holding worthless shares. This deceptive practice is rampant, and call options are frequently exploited to amplify the gains from such fraudulent activities.
Exceptional Penny Stocks and Lucrative Opportunities
While the vast majority of penny stocks are indeed worthless, there are rare exceptions where penny stocks present legitimate investment opportunities. For instance, a company experiencing unforeseen challenges or undergoing restructuring could momentarily appear to be a low-value gem. In these cases, a call option can be strategically used to capture potential returns when the company regains its footing.
Historically, companies such as Ford Motor Company, Bank of America, and several tech giants like Microsoft and Intel started in penny stock territory before achieving remarkable success. However, these instances are the exception rather than the rule. For the average investor, particularly new ones, the risk is far too high.
Why Not Invest in Penny Stocks?
Many reputable investment firms, including mutual funds, actively avoid penny stocks due to the significant risks involved. Unsuspecting investors are often lured by promises of high returns, similar to the pump and dump scheme, only to be left with little more than fraudulently inflated stock prices.
The allure of becoming fabulously wealthy through a few lucky penny stock picks is a dangerous illusion. Novice investors should tread cautiously, avoiding the false promise of ease and high returns that accompanies penny stock investments and their associated call options.
My general advice is to approach penny stocks with a high degree of skepticism. Be wary of unsolicited emails or messages urging you to buy at the bottom before the stock rockets to unsustainable levels. Too good to be true almost always is true in the realm of penny stocks. Instead, focus on well-researched and established companies with proven track records, using options, where appropriate, for other investment strategies.