EXHIBIT 1.2 Long Intel call vs. long Intel stock.
The thin dotted line represents owning 100 shares of Intel at $22.25.
Profits are unlimited, but the risk is substantial—the stock can go to zero.
Herein lies the trade-off. The long call has unlimited profit potential with
limited risk. Whenever an option is purchased, the most that can be lost is
the premium paid for the option. But the benefit of reduced risk comes at a
cost. If the stock is above the strike at expiration, the call will always
underperform the stock by the amount of the premium.
Because of this trade-off, conservative traders will sometimes buy a call
rather than the associated stock and sometimes buy the stock rather than the
call. Buying a call can be considered more conservative when the volatility
of the stock is expected to rise. Traders are willing to risk a comparatively
small premium when a large price decline is feared possible. Instead, in an
interest-bearing vehicle, they harbor the capital that would otherwise have
been used to purchase the stock. The cost of this protection is acceptable to
the trader if high-enough price advances are anticipated. In terms of
percentage, much higher returns and losses are possible with the long call.
If the stock is trading at $27 at expiration, as the trader in this example
expected, the trader reaps a 429 percent profit on the $0.85 investment