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Demo Trade
Buy LEAPS Calls to Anticipate a Rally
| Stock Assumption: |
Bullish |
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Situation: |
An investor anticipates an advance in the stock of one of the LEAPS issues over the next two years. |
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Possible Market Action: |
Buy Equity LEAPS® Calls |
An investor anticipates an advance in the price of a stock underlying a LEAPS issue over the next two years. He would like to profit from a rise in the stock without having to purchase the shares.
ZYX is currently trading at 50-1/2 and a 2 year LEAPS call with a 50 strike price is trading for 8-1/2. The investor purchases five of these for $4,250. These five calls give him the right to buy 500 shares of ZYX between now and expiration at 50 no matter how high the stock should rise. The break-even level in this example is 58 1/2 (strike price + premium paid).
If ZYX advances to 65 by this date, the individual has the choice of exercising the five calls and taking delivery of the stock by paying $50 per share or selling the LEAPS for a profit. At expiration, the LEAPS will be trading for at least 15 with ZYX at 65.
| Buy Five LEAPS ZYX 50 Calls | |
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Closing Sale Price (5 x 100 x 15): |
$7,500 |
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Less premium paid (5 x 100 x 8-1/2): |
$4,250 |
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Profit in this situation: |
$3,250 |
The risk is only the total cost of the calls, $4,250 plus commissions if ZYX does not rise above 50 by the expiration date. The LEAPS may trade somewhat higher than the difference between the 50 strike price and actual stock price due to the possibility that the stock price may increase over the time remaining to expiration. This is known as time value and the amount of time value contained in an options premium will decrease as expiration approaches. Note that an investor may lose the entire amount of $4,250 plus commissions in
a short amount of time.