Definition
This is one of the simplest strategies where you buy the CALL for a stock at a particular Strike price.
The Buyer of the CALL is expecting the price of the stock to go up but either doesn’t have money to buy the stock immediately or want to avoid the loss in case the stock falls down below the Strike price.
When to run the strategy
The owner of the Stock is expecting the Stock to go up but doesn’t want to buy the stock. Also, the returns on the trade can be multi fold even with slight increase in stock price for the CALL buyer.
Benefits of strategy
· You don’t own the underlying stock so is not affected if the stock tanks.
· You can make multi baggers with a slight increase in the stock price
Transactions
· You Buy the CALL at the Strike Price (S) (say $110) by paying the premium (P) (say $7).
Max Profit
There is no Cap to the Max Profit since there is no upper limit for the Stock.
Example for Potential profit:
Strike Price: $110
Strike Price at Expiration $300
Premium: $7
So Profit = $300 - $110 - $7 = $183
Potential and Max Loss
Potential Loss is
(Strike price of option + Premium) - Stock Price at Expiration
Example,
Strike price of CALL $110
Stock Price at Expiration (say): $112
Premium: $7
So Potential Loss= ($110 + $7) - $112 = $5
Max Loss occurs when stock value at expiration is less than Strike price.
Max loss = Premium paid for the CALL
Breakeven point
This occurs when the value of the stock increases by the similar amount as the premium paid. It occurs when the stock price at expiration is (Strike Price + Premium).
Example:
Strike Price for CALL- $110
Premium paid - $7
So Stock price at breakeven point should be (110 +7) = $117
At Expiration
Ø If the Stock price is above Strike price:
You are assigned the stock at the Strike Price. If the Stock price is a more than the Strike Price + Premium, you have made a profit…
Note: You can close the CALL before the expiration by selling it in the Options market..
Ø If the Stock price is below Strike price:
The CALL Option expires worthless.
You have lost all your investment..
Who should trade this?
Since this strategy has medium risk and if not traded properly, you can lose all your investment, it should not be traded by beginners.
Beginners - No
Intermediates - Yes
Experts - Yes
Masters - Yes
Time decay
Ø Time Decay works against you.
Ø As Expiration date approaches, the time value of Option will reduce.
Ø The time values reduce to 0 on the day of Expiration.
Points to consider
Ø Exit strategy: If Stock falls or doesn’t show any movement, you may want to close the CALL position by selling the CALL.
Ø Brokerage Cost: Always consider brokerage cost when making a trade.
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