Description
Call buying is
a strategy used
if the investor
thinks that XYZ
will advance in
price. It is important,
given the risk,
that the investor
have a clear idea
about where the
stock is going and
when. Simply thinking
XYZ is a "great
company that is
sure to go up" is
not enough. A Call
purchase based on
such vague notions
is likely to cause
frustration as losses
mount when the advance
fails to materialize.
Buying Calls:
Why?
For the most
part, there are
two types of Call
buyers:
- the bullish speculators wanting to take advantage of the leverage options can offer, and
- the investor buying a Call as a substitute for buying the stock.
Risk/Reward
Characteristics
Break-even
Point: At expiration,
the break-even point
(B.E.) is equal
to the strike price
of the Call option
plus the Call option's
premium. Before
expiration, the
break-even point
is lower.
Profit:
Profits are unlimited
as long as the underlying
stock continues
in advance.
Loss:
Losses are limited
to the premium paid
for the option.
At expiration, for
every point XYZ
is above the strike
price, the Call
option increases
an additional point
in value.
Time Decay:
A call option's
premium consists
of both intrinsic
value (if any) plus
time value. As time
passes, the time
value portion of
the Call erodes
(i.e., decays).
At expiration, the
Call's value will
equal its intrinsic
value.
Changes in
implied Volatility:
Changes in the option's
implied volatility
has an effect on
the "time value"
portion of an option's
premium. Thus, a
change in the option's
implied volatility
has the same effect
as changing (+/-)
the number of days
remaining until
the option's expiration.
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