Who Should Consider Buying Calls?
• An investor who is very bullish on a particular stock.
• An investor who would like to take advantage of what purchasing options offers:
leverage with a limited dollar risk.
• An investor who anticipates a rise in the value of a particular stock
but does not want to commit all of the capital needed to purchase the stock.
Buying a call is a simple option strategy and one that is often used. Although buying calls may not be suitable
for everyone, it allows the investor the opportunity to profit from an upward move in the underlying stock
while having very little capital at risk compared to the amount needed to own the stock.
Definition
Buying a call gives the owner the right, but not the
obligation, to buy the underlying stock at a specified
price (the strike price) within a specific period of time.
The risk for the call buyer is limited to the premium
paid for the call (the price of the call) plus
commissions. The profit potential is unlimited as the
underlying stock rises above the strike price plus the
premium paid for the call plus commission or the
breakeven. The value of the call tends to increase as the
price of the underlying stock rises. This gain will
increasingly reflect a rise in the value of the underlying
stock when the market price moves above the option’s
strike price.
Participate in upward movement,
limit downside risk
An investor may buy a call in order to participate in
the upward movement of a stock while limiting his
downside risk. In this example ZYX is trading at
44.25. Instead of spending $22,125 for 500 shares of
ZYX stock, an investor could purchase a six-month call
with a 45 strike price for 3.25. By purchasing a six
month call with a 45 strike for 3.25, the investor is
saying that he anticipates ZYX will rise above the
strike of 45 (which is where ZYX can be purchased no
matter how high ZYX has risen) + 3.25 (the option
premium), or 48.25, by expiration. Each call
represents 100 shares of stock, so 5 calls could be
bought in place of 500 shares of stock. The cost of 5
calls at 3.25 is $1,625 (5 calls x 3.25 x $100). Instead
of spending $22,125 on stock, only $1,625 is needed
for the purchase of the 5 calls. The balance of $20,500
could then be invested in short-term instruments. This
investor has unlimited profit potential as ZYX rises
above 48.25. The risk for the option buyer is limited
to the premium paid, which in this example is $1,625.
Commissions and taxes have not been taken into
consideration in these examples, although they can
have a significant affect on the investor's returns.
Buying 5 ZYX 6-Month 45 Calls at 3.25 vs. Buying 500 Shares ZYX @ 44.25
I. ZYX is above 48.25 by expiration.
ZYX has risen above the breakeven of 48.25. The investor has two choices: either sell the calls and take the
profit or exercise his right to buy ZYX.
If ZYX is at 51 at expiration, the option will be worth the difference between the strike and the current price of the
stock:
$51(current price)
-45 (strike price)
$ 6 (current option value)
The option could be sold and a 85% return would be earned on the initial investment.
$6
(current option value)
$3.25 (premium paid for option)
$2.75 (profit, if option sold)
The 5 calls could also be exercised and 500 shares of ZYX would be purchased for $45 per share even though the
stock is trading at $51 per share. The right to buy the stock at 45 cost 3.25 so the breakeven on the stock position
in ZYX is 48.25.
Had the stock been purchased at 44.25 (a cost of $22,125), and it rose to 51, it would now be worth $25,500.
This would be a 15.3% increase in value over the original cost of $22,125. But, the call buyer spent only $1,625
and earned 85% on his options.
Total
Stock
Purchase
Price
Stock
Price at
Expiration
Value
of 500
Shares
+/Stock
Purchase
Price
Option
Value at
Expiration
44.25
51
$25,500
+$3,375
3.25
6
*plus interest earned on cash not used, cost of stock less call premium.
Option
Value of
5 Calls
Total
+/Option
$3,000
+$1,375*
II. ZYX is between 45 and 48.25 at expiration.
The investor’s option will still hold some value if the underlying is between 45 and 48.25 (breakeven), but not
enough to breakeven on the position. The option can still be sold to recoup some of the cost.
For example, ZYX is at 47 on the last day of trading, usually the third Friday of the expiration month. The option
can be sold to close out the position through the last trading day of the call. ZYX did rise in value but not as much
as anticipated. The option that cost 3.25 is now worth 2 points. Instead of letting the option expire, you could sell
the call and recoup some of your losses.
-3.25
-2
-1.25
= (Cost)
= (Sale)
= Net loss (excluding commissions)
If just the stock had been bought and the stock rose to 47, $1,375 would have been earned while the holder of
calls would have lost $625. However, the holder of calls would have been earning interest on $20,500, which
would offset some of the loss in the options.
Total
Stock
Stock
Purchase
Price at
Price
Expiration
44.25
51
44.25
47
*Plus interest earned on cash
Value
Option
Option
of 500
+/Purchase
Value at
Shares
Stock
Price
Expiration
$25,500
+$3,375
3.25
6
$23,500
+$1,375
3.25
2
not used, cost of stock less call premium.
Value of
5 Calls
$3,000
$ 1,000
Total
+/Option
+$1,375*
-$ 625*
III. ZYX is at or below 45 at expiration.
ZYX is now at 40 and the option has expired worthless. The premium that was paid for the calls has been lost.
However, had the stock been bought the investor would now be in a losing stock position hoping to breakeven.
By purchasing a call he had limited capital at risk. Now he still has most of the money that he would have spent
to buy the stock plus interest and he can make another investment decision.
Total
Stock
Purchase
Price
Stock
Price at
Expiration
44.25
51
44.25
47
44.25
40
*Plus interest earned on cash
Value
of 500
Shares
Total
+/Stock
Option
Purchase
Price
Option
Value at
Expiration
$25,500
+$3,375
3.25
$23,500
+$1,375
3.25
$20,000
-$2,125
3.25
not used, cost of stock less call premium.
6
2
0
Value of
5 Calls
Total
+/Option
$3,000
$1,000
$1,000
+$1,375*
-$1,625*
-$1,625*
If the investor had purchased ZYX at 44.25, and the stock did not move as he anticipated, the investor would
have had two choices: sell the stock, and after commission costs, incur some losses, or hold onto it and hope that
it rises over the long-term. Had he bought the options and he was wrong, the options would expire worthless
and the loss would be limited to the premium paid.
Summary
For those who are very bullish on particular stock over the near or long-term, buying a call might be just the
strategy to use. Currently, there are short-term options listed on more than 1,400 stocks and more than 350 of
those stocks also have LEAPS®, Long-term Equity AnticiPation SecuritiesTM, which are simply long-term stock
and index options. Today’s investor has a choice of short-term and long-term expirations, as well as multiple
strike prices, so no matter what his outlook is, there is a call which meets his market opinion. The owner of a call
has the opportunity to profit from a rise in the stock with very little capital at stake compared to the amount
necessary to buy the underlying security. The most that a call owner can lose is the amount paid for the option,
yet he has unlimited profit potential as the stock rises above the strike price.
FREE interactive strategies are available at www.cboe.com
Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of
Standardized Options. Copies may be obtained by contacting your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation at
www.theocc.com. In order to simplify the computations, commissions, dividends, fees, margin interest and taxes have not been included in the examples used
in this document. These costs will impact the outcome of stock and options transactions and must be considered prior to entering into any transactions.
Investors should consult their tax advisor about any potential tax consequences. The strategy discussed above is strictly for illustrative and educational purposes
only and is not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. LEAPS® is a registered trademark and Long-term
Equity AnticiPation SecuritiesSM is a service mark of Chicago Board Options Exchange, Incorporated (CBOE).
Copyright © 2012 CBOE. All rights reserved.