### Index Options Strategies: Buying Index Calls - Part Two

...Continued from Part One

Scenario

Assume the underlying index that interests you is symbolized as XYZ and is currently at a level of 200. You decide to purchase a 6-month XYZ 205 call for a quoted price of \$4.75 per contract. Your net cost for this call is \$475 (\$4.75 x 100 multiplier). You are risking \$475 if the underlying index level is not above the strike price of 205 when the XYZ call expires.

The break-even point (BEP) at expiration is an XYZ index level of 209.75 (strike price 205 + premium paid \$4.75) because the call will be worth its intrinsic value of \$4.75, which is what you originally paid for it. The higher the XYZ index settlement value is above the break-even point at expiration, the greater your profit.

Possible Outcomes at Expiration

1. XYZ index level above the break-even point (209.75):

If at expiration XYZ index has advanced to 215, the XYZ 205 call will be worth its intrinsic value of \$10 (settlement value 215 - strike price 205). Your net profit in this case would be \$525 (settlement amount \$1000 received from exercise - net cost of call \$475).

Buy XYZ Index 205 Call at \$4.75 with Index at 200 Net Cost for Call = \$475
Level of XYZ Index at expiration XYZ Index Declines to 198
(below strike)
(between strike and BEP)
(above BEP)
Move in level of index down 2 pts. up 7 pts. up 15 pts.
Value of call at expiration
(per contract)
0
(out-of-the-money)
\$2 \$10
Less premium paid for call \$4.75 \$4.75 \$4.75
Net profit/loss*
(per contract x 100)
ñ\$475 ñ\$275 \$525

*Exclusive of commissions, transaction costs and taxes.

2. XYZ index level between strike price (205) and break-even point (209.75):

If at expiration XYZ index has advanced to 207, the XYZ 205 call will be worth its intrinsic value of \$2.00 (settlement value 207 - strike price 205). You could exercise the option and receive the settlement amount of \$200 (\$2.00 intrinsic value x 100 multiplier).

This amount would be less than the net amount paid for the call (\$475), but it would offset some of that cost. The net loss in this case would be \$275 (net cost of call \$475 - settlement amount \$200 received from exercise). This loss represents a little more than half of your initial investment.

3. XYZ index level below strike price (205):

If at expiration XYZ index has declined to 198, the call would have no value because it is out-of-the-money. You will have lost all of your initial investment, a net of \$475. The net premium paid for an index option represents the maximum loss for an option purchaser.

Note: No matter how far XYZ declines below the strike price, the loss will not exceed \$475.
"

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