Participate in an Decreasing OEX Level with Limited Upside 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 600. An investor could purchase one three-month OEX 595 put, which represents the right to sell the OEX index at a level of 595, for a quoted price of $11. The total cost for the put would be: $11 x $100 contract multiplier = $1,100. By purchasing the OEX put the investor is saying that by expiration he anticipates OEX index to have declined below the break-even point: $595 strike price – $11 (the option premium paid), or an OEX level of 584.
The investor’s profit potential can be significant as the level of the OEX index continues to decline below 584, and is theoretically limited only because an index can decline to no less than zero. The risk for the put purchase is limited entirely to the total premium paid for the contract, or $1,100, no matter how high the level of OEX might increase.
Before expiration, if the put 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 bearish outlook proves incorrect and the OEX index increases in price, the put 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.
Consider three possible scenarios at expiration:
- OEX exercise settlement value below the break-even point
- OEX exercise settlement value between the strike price and the break-even point
- OEX exercise settlement value above the strike price