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