Participate in an Increasing OEX Level with Limited Downside Risk
Please note: Commission, dividends, margins, taxes and other transaction charges have not been included in the following examples. However, these costs can have a significant effect on expected returns and should be considered. Because of the importance of tax considerations to all options transactions, the investor considering options should consult with his/her tax advisor as to how taxes affect the outcome of contemplated options transactions.
Say the OEX index is currently at 600. An investor could purchase one three-month OEX 605 call, which represents the right to purchase the OEX index at a level of 605, for a quoted price of $14. The total cost for the call would be: $14 x $100 contract multiplier = $1,400. The underlying asset value for this option is the current index level 600 x $100 multiplier = $60,000. Instead of committing $60,000 to a bullish, speculative outlook on OEX at current levels, spending only $1,400 for the purchase of one call would leave a balance of $58,600 that could then be invested elsewhere.
By purchasing the call the investor is saying that by expiration he anticipates the OEX index to have risen above the break-even point: $605 strike price + $14 (the option premium paid), or an OEX level of 619. The investor’s profit potential is unlimited as OEX’s level continues to rise above 619. The risk for the call purchase is limited entirely to the total $1,400 premium paid for the contract no matter how low the OEX index declines.
Before expiration, if the call purchase becomes profitable the investor is free to sell the option in the marketplace to realize this gain, or to exercise it. On the other hand, if the investor’s bullish outlook proves incorrect and the OEX index declines in price, the call might be sold or exercised to realize a loss less than the maximum.
NOTE: An investor holding a long OEX call or put has the right to exercise the contract, and receive its cash settlement amount, at any time before expiration. However, because of any time value remaining in the option’s premium it might be more profitable to sell the contract in the marketplace up to an including its last trading day. Be aware of this when considering an early exercise of any long OEX option.
Buy 1 OEX 605 Call at $14
Consider three possible scenarios at expiration:
- OEX exercise settlement value above the break-even point
- OEX exercise settlement value between the strike price and the break-even point
- OEX exercise settlement value below the strike price