43 lines
1.7 KiB
Plaintext
43 lines
1.7 KiB
Plaintext
Option Fundamentals • 15
|
||
In this sold call example, we again see the shaded area representing
|
||
the exposure range. We also see that the exposure is limited to 500 days
|
||
and that it starts at the $60 strike price. The big difference we see between
|
||
this diagram and the one before it is that when we gained upside exposure
|
||
by buying a call, we had potentially profitable exposure infinitely upward;
|
||
in the case of a short call, we are accepting the possibility of an infinite
|
||
loss. Needless to say, the decision to accept such risk should not be taken
|
||
lightly. We will discuss in what circumstances an investor might want to
|
||
accept this type of risk and what techniques might be used to manage that
|
||
risk later in this book. For right now, think of this diagram as part of an
|
||
explanation of how options work, not why someone might want to use this
|
||
particular strategy.
|
||
Let’s go back to the example of a long call because it’s easier for
|
||
most people to think of call options this way. Recall that you must pay a
|
||
premium if you want to gain exposure to a stock’s directional potential. In
|
||
the diagrams, you will mark the amount of premium you have to pay as a
|
||
straight line, as can be seen here:
|
||
5/18/2012
|
||
-
|
||
20
|
||
40
|
||
60
|
||
80
|
||
100
|
||
120
|
||
140
|
||
160
|
||
180
|
||
200
|
||
5/20/2013 249
|
||
Breakeven Line: $62.50
|
||
499
|
||
Date/Day Count
|
||
Stock Price
|
||
749 999
|
||
GREEN
|
||
I have labeled the straight line the “Breakeven line” for now and have as-
|
||
sumed that the option’s premium totals $2.50.
|
||
Y ou can think of the breakeven line as a hurdle the stock must cross
|
||
by expiration time. If, at expiration, the stock is trading for $61, you have
|
||
the right to purchase the shares for $60. Y ou make a $1 profit on this trans-
|
||
action, which partially offsets the original $2.50 cost of the option. |