Who Should Consider Buying Index Calls?
- An investor who is very bullish on a particular broad market or industry sector index, and wants to profit from a rise in its level.
- An investor who wants to diversify a portfolio, but may not be willing to commit the cash to an investment in a portfolio of multiple stocks.
- An investor who would like to take advantage of the leverage that options can provide, and with a limited dollar risk.
Buying an index call is one of the simplest and most popular strategies used by option investors employing index options. It allows an investor the opportunity to profit from an upward move in the price of the underlying index, while having much less capital at risk than with the outright purchase of possibly scores of component issues.
Buying an index call gives the owner the right, but not the obligation, to buy upon exercise the value of the underlying index at the stated exercise (strike) price before the option expires. American-style index options may be exercised at any time before the contracts expire. European-style index options may be exercised only within a specific period of time, generally on the last business day before expiration. However, any long index option may be sold in the marketplace on or before its last trading day if it has market value. All index options are cash-settled. For contract specifications for various index option classes, please visit the Index Options Product Specification area here.
This is a bullish strategy because the value of the call tends to increase as the level of the underlying index rises, and this gain will increasingly reflect a rise in the value of the underlying index when its level moves above the option’s strike price.
The profit potential for the long call is unlimited as the underlying index continues to rise. The financial risk is limited to the total premium paid for the option, no matter how low the underlying index declines.
The break-even point is an underlying index level equal to the call’s strike price plus the premium paid for the contract. As with any long option, an increase in volatility has a positive financial effect on the long call strategy while decreasing volatility has a negative effect. Time decay has a negative effect.