Participate in an Increasing SPX 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 SPX index is currently at 1400. An investor could purchase one three-month SPX 1410 call, which represents the right to purchase the SPX index at a level of 1410, for a quoted price of $34. The total cost for the call would be: $34 x $100 contract multiplier = $3,400.
The underlying asset value for this option is the current index level 1400 x $100 multiplier = $140,000. Instead of committing $140,000 to a bullish, speculative outlook on SPX at current levels, spending only $3,400 for the purchase of one call would leave a balance of $136,600 that could then be invested elsewhere.
By purchasing the call the investor is saying that by expiration he anticipates the SPX index to have risen above the break-even point: $1410 strike price + $34 (the option premium paid), or an SPX level of 1444. The investor’s profit potential is unlimited as SPX’s level continues to rise above 1444. The risk for the call purchase is limited entirely to the total $3,400 premium paid for the contract no matter how low the SPX 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. On the other hand, if the investor’s bullish outlook proves incorrect and the SPX index declines in price, the call might be sold to realize a loss less than the maximum.
Buy 1 SPX 1410 Call at $34
Consider three possible scenarios at expiration:
- SPX exercise settlement value above the break-even point
- SPX exercise settlement value between the strike price and the break-even point
- SPX exercise settlement value below the strike price