An Example

In an example, ZYX is trading at 44 1/4. Instead of spending $22,125 for 500 shares of ZYX stock, an investor could purchase a six-month call with a 45 strike price for 3 3/8. By purchasing a six month call with a 45 strike for 3 3/8, the investor is saying that he anticipates ZYX will rise above the strike of 45 (which is where ZYX can be purchased no matter how high ZYX has risen) + 3 3/8 (the option premium), or 48 3/8, by expiration. Each call represents 100 shares of stock, so 5 calls could be bought in place of 500 shares of stock. The cost of 5 calls at 3 3/8 is $1,687.50 (5 calls x 3 3/8 x $100). Instead of spending $22,125 on stock, only $1,687.50 is needed for the purchase of the 5 calls. The balance of $20,437.50 could then be invested in short-term instruments. This investor has unlimited profit potential as ZYX rises above 48 3/8. The risk for the option buyer is limited to the premium paid, which in this example is $1,687.50. Commissions and taxes have not been taken into consideration in these examples, although they can have a significant affect on the investor's returns. Had the stock been purchased at 44 1/4 (a cost of $22,125), and it rose to 51, it would now be worth $25,500. This would be a 15.3% increase in value over the original cost of $22,125. But, the call buyer spent only $1,687.50 and earned 77% on his options.