Close Below Strike

ZYX is at or below $45 at expiration

chart 1

Say ZYX stock did not move as anticipated, but instead declined and closes at $40 per share at expiration. The ZYX call would expire out-of-the-money and with no value, so the investor would lose the total premium of $325 initially paid for the option. This would be the limited, maximum loss no matter how far ZYX stock had declined, and would also be realized if at expiration ZYX closed at any point at or below the $45 strike price and the call expired out-of-the-money.

chart 2

Assume the same scenario of ZYX closing at $40 on expiration and consider an initial purchase of 100 shares at $44.25 instead of the call. At $40 per share, the 100 shares would have declined in value to $4,000. The stock investor would be facing an unrealized loss of $425, and would have incurred a greater loss if ZYX stock had declined even further. The option investor's loss, however, is limited to the $325 premium paid for the contract. The stock investor now has two choices: sell the stock and realize this loss, or hold onto the stock and hope for an increase in price to recoup some or all of the loss.

By purchasing the call for significantly less cash than an outright purchase of 100 ZYX shares, the investor limited the investment capital at risk if ZYX stock did not increase in price as anticipated. Now he still has the cash balance of his original investment capital, plus interest if it had been invested in short-term interest bearing instruments, with which to make another investment decision.

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