Limited Participation in an Increasing OEX Index 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.
An investor is moderately bullish on OEX index over the next couple of months, with the OEX currently at 602, and decides to establish an OEX 600/605 bull call spread. He purchases one two-month OEX 600 call for a price of $14.50, and at the same time sells (writes) one two-month OEX 1405 call and receives $11.75. The total net debit for the spread is $14.50 – $11.75 = $2.75 x $100 contract multiplier = $275.00.
By purchasing the bull call spread the investor is saying that by expiration he anticipates the OEX index to have risen moderately to a level above the break-even point (BEP): $600 strike price + $2.75 (the net debit paid), or an OEX level of 602.75. The investor’s maximum profit potential is limited: 605 (higher strike) – 600 (lower strike) = $5.00 – $2.75 (net debit paid) = $2.25 x $100 multiplier = $225 total. This profit would be seen no matter how high OEX index has risen by expiration. The downside risk for the bull call spread purchase is limited entirely to the total $275 premium paid for the spread no matter how low the OEX index declines.
Before expiration, if the call spread purchase becomes profitable the investor is free to sell the spread in the marketplace to realize this gain. On the other hand, if the investor’s moderately bullish outlook proves incorrect and the OEX index declines in price, the call spread might be sold to realize a loss less than the maximum.
| Buy 1 OEX 600/605 Call Spread at $2.75 Debit
Consider three possible scenarios at expiration:
- OEX exercise settlement value at or above the higher strike price
- OEX exercise settlement value between the strike prices
- OEX exercise settlement value at or below the lower strike price