Call Option Basics

In order to begin to understand why we believe an Integrated Options Portfolio is superior to traditional directly held portfolios, let’s first evaluate the risks and benefits of buying a “call” option.

When we buy call options on a stock or fund, we have the right (not the obligation) to purchase the shares of that stock or fund at a fixed price (called the Strike Price) anytime on or before the date that the option expires.  The value of the options is determined by market forces and is closely related to the value of the stock or fund.

It is important to know that the potential gains from owning these options are unlimited, but the potential loss is limited to the amount paid for the option.

Example #1:

We have $50,000 and would like to buy $50,000 worth of the “ABC” Stock Fund valued at $50/share.  We could just purchase 1000 shares, or…

We can purchase call options at the $47 strike price that expire in 2 years, currently valued at $6.50/share.  Buying these options on 1000 shares would cost us $6,500 today.  The value of these contracts will fluctuate with the market, but at expiration, they will be worth the difference between the contract’s strike price ($47) and the current market price.

If the “ABC” Fund is valued at $75/share on expiration day, our options would be worth $28,000 (($75 market price-$47 strike price) x 1000 shares.) or a 330% return on our $6,500.

If the “ABC” Fund is valued at $35/share on expiration day, our options would be worth $0 (There is no value in using our options contract to buy at $47/share when the shares can be bought at $35/share) a 100% loss on our $6,500.

If we graph all the possible prices between $0 and $100/share for the “ABC” Fund on the day the options expire, we get a good feel for how owning our options compares with buying the stock directly.  The blue line represents the profit or loss of the fund directly held and the orange line displays the profit or loss if we were to just buy an option on the same fund.

Profit/(Loss) at Expiration

Profit/(Loss) at Expiration

Do you see how our losses are limited to the price paid for the options, but our potential is unlimited?  This is one reason why to buy call options.

Popularity of Options

You should know that the options market is huge and growing exponentially as more and more investors understand the power of options.

Now that we’ve taken care of some of the groundwork, take the next step and let us show you why we believe the Integrated Options Portfolio is superior to direct ownership investment management.

Next Step: Integrated Options Portfolio 101