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Buying Index Calls


Index XYZ is between 505 and 516 at expiration

Buy 1 XYZ 505 Call at $11

With index XYZ exactly at the strike price of $505 at expiration, the 505 call would be exactly at-the-money and have no value. With XYZ at the break-even point of 516 at expiration the call’s intrinsic value would be $11, or its initial cost. With XYZ closing between 505 and 516 at expiration, the 505 call will be in-the-money and have an intrinsic value of less than its initial cost. In this case the option could be sold to recoup some of its original purchase price resulting in a partial loss for the position.

For example, index XYZ closes at 510 at expiration. The call’s intrinsic value at this point would be:

   510   XYZ index level
-$505   call strike price
    $5    intrinsic value

XYZ did rise in value, but not as much as anticipated. The option that cost $11 is now worth $5, so the investor can sell the call and recoup some of its initial purchase price. If the XYZ 505 call is sold for its intrinsic value of $5 then the loss for the position would be:

$11.00   premium initially paid for call
-$5.00   premium received at call’s sale
 $6.00   partial loss

With XYZ at 510 at expiration, the in-the-money XYZ 505 call could also be exercised. The exercise settlement value would be the closing index level of 510. The cash settlement amount would be: 510 (settlement value) – $505 (call strike price) = $5. The partial loss would be the same as if the call were sold for intrinsic value at expiration:

$11.00   premium initially paid for call
-$5.00   settlement received at call’s exercise
 $6.00   partial loss

However, the call buyer could have earned interest on the $48,900 not originally committed to this bullish position, which could offset some of the option loss.


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