30 lines
1.9 KiB
Plaintext
30 lines
1.9 KiB
Plaintext
Buy Call
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Why buy the right to buy the stock when you can simply buy the stock? All
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option strategies have trade-offs, and the long call is no different. Whether
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the stock or the call is preferable depends greatly on the trader’s forecast
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and motivations.
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Consider a long call example:
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Buy 1 INTC June 22.50 call at 0.85.
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In this example, a trader is bullish on Intel (INTC). He believes Intel will
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rise at least 20 percent, from $22.25 per share to around $27 by June
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expiration, about two months from now. He is concerned, however, about
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downside risk and wants to limit his exposure. Instead of buying 100 shares
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of Intel at $22.25—a total investment of $2,225—the trader buys 1 INTC
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June 22.50 call at 0.85, for a total of $85.
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The trader is paying 0.85 for the right to buy 100 shares of Intel at $22.50
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per share. If Intel is trading below the strike price of $22.50 at expiration,
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the call will expire and the total premium of 0.85 will be lost. Why? The
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trader will not exercise the right to buy the stock at a $22.50 if he can buy it
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cheaper in the market. Therefore, if Intel is below $22.50 at expiration, this
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call will expire with no value.
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However, if the stock is trading above the strike price at expiration, the
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call can be exercised, in which case the trader may purchase the stock
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below its trading price. Here, the call has value to the trader. The higher the
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stock, the more the call is worth. For the trade to be profitable, at expiration
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the stock must be trading above the trader’s break-even price. The break-
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even price for a long call is the strike price plus the premium paid—in this
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example, $23.35 per share. The point here is that if the call is exercised, the
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effective purchase price of the stock upon exercise is $23.35. The stock is
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literally bought at the strike price, which is $22.50, but the premium of 0.85
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that the trader has paid must be taken into account. Exhibit 1.1 illustrates
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this example. |