Strategies

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Buying Index Calls

 

Index XYZ is above break-even point of 516 at expiration
 

Buy 1 XYZ 505 Call at $11

 
If index XYZ closes above the break-even point of 516 at expiration, at 520 for instance, the option will be in-the-money and worth its intrinsic value, or its cash settlement amount (difference between the strike price and index level):

   520   XYZ index level
 -$505   call strike price
   $15   intrinsic value (cash settlement amount)

If you sell the XYZ 505 call for its intrinsic value of $15 then you would see a profit:

 $15.00  intrinsic value received at call’s sale
-$11.00  premium initially paid for call
   $4.00  profit

This profit of $4.00 ($400 total) represents a return on an initial investment of $11 premium paid for the call ($1,100 total) of approximately 36.4% over the 3-month life of the call contract.

With XYZ at 520 at expiration, the in-the-money XYZ 505 call could also be exercised. The exercise settlement value would be the closing index level of 520. The cash settlement amount would be: 520 (settlement value) – $505 (call strike price) = $15. The profit would be the same as if the call were sold for intrinsic value at expiration:

 $15.00  settlement amount received at call’s exercise
-$11.00  premium initially paid for call
   $4.00  profit

 
 

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