17.12 Options strategies

Hanumant Dhokle



For aggressive investors who are very bullish about the prospects for a stock / index, buying calls can be an excellent way to capture the upside potential with limited downside risk. 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.

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

Risk: Limited to the Premium. (Maximum loss if market expires at or below the option strike price).

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.

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