Page 1 of 2 Option strategies – buying call options Bullish strategies for $30 and it subsequently declined to has no intrinsic value. This options The call option gives the buyer the right, $20, they would have a $10 loss on the premium is comprised of time value but not the obligation, to purchase the position. This is a much larger loss than only. If the underlying stock price underlying stock at a predetermined the option investor would experience. remains below the option strike price price over a specified time period. This is an example of the limited risk this option will have no value at the The predetermined price is called that options buyers enjoy. expiration date. The erosion of time 10 the strike price. Listed options have value tends to accelerate as the options 8 expiration date approaches. expiration dates on the third Friday of 6 every month. The purchase price of the 4 Up to this point, we have been looking option is referred to as the premium. 2 Long Call 0 at option values at expiration. Option These option contracts each represent -2 premiums will fluctuate with the stock 100 shares of the underlying stock. -4 -20 22 24 26 28 30 32 34 36 38 40 price throughout the life of the option. Therefore, the purchase of 10 calls -2 -2 -2 -2 -2 -2 -2 -2 468 The measurement of this movement would give the holder exposure to 1,000 is referred to as DELTA. DELTA tells us shares of the stock. n Stock price how an options price should react to a n Long call P&L at expiration Long call example change in the underlying stock price. With the underlying stock trading at $30, DELTA option example an investor may choose to purchase a Options are a wasting asset An option with a DELTA of .50 would call option that expires in two months be expected to move $0.50 for a $1.00 with a strike price of $30. The investor An options premium is made up of move in the underlying stock. This pays a $2 premium for the right to two components: intrinsic value and option has a 50% correlation to the buy the stock at $30 for the next two time value. stock price. A good rule of thumb to use months. The underlying stock price Options premium example is that all options whose strike price must be trading above the options strike is equal to the current stock price will price plus the premium paid ($32), by With the underlying stock trading a $32, the have a DELTA of approximately 0.50. A the expiration date, for the investor to three-month $30 strike call trades at $3. call option’s DELTA will increase as the realize a profit. This price is referred stock price moves above the call’s strike to as the “break even” price. Once the Intrinsic value = $2 price. The further the call option goes stock has exceeded this price level, the + Time value = $1 “in the money,” the higher its DELTA investor participates point for point as Premium = $3 becomes, and therefore, the greater its the stock moves higher. Conversely, if correlation with the movement of the the stock price declines and finishes In this example, if the stock remains underlying stock. Conversely, if the below the call strike, the investor stands at $32 until the expiration date, the stock price declines below the option’s to lose 100% of their investment. While option will lose its entire time premium strike price, the DELTA will decrease this sounds harsh, remember the $2 and would trade at $2 (the intrinsic and the option will be less influenced by investment represents a fraction of the value). A call option with a strike price the stock’s price fluctuations. As you can price to purchase the stock outright. If that is greater than the stock price is see, an option’s DELTA is dynamic and the investor had purchased the stock considered “out of the money” and will change as the stock price changes. Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested. Page 2 of 2 Option strategies – buying call options, continued Because buying call options can be viewed as a substitute for buying the underlying stock, investors should only purchase the same number of call options that they would round lots of stock. As stated earlier, options are a wasting asset and while they offer limited risk they have the potential of expiring worthless. Buying an excess number of call options is an example of over-leveraging. A few things to remember • Buying longer-term options gives the underlying stock more time to perform as expected and helps delay the accelerated time decay as expiration approaches. • Buying “in-the-money” call options gives you a higher correlation with the movement in the underlying stock. • Buying an equivalent number of call options as you would round lots of stock will help reduce the risk of over- leveraging. This strategy sheet discusses exchange-traded options. It is not to be construed as a recommendation to purchase or sell a security. Before engaging in the purchasing or writing of exchange-traded options, investors should understand the nature and extent of their rights and obligations and be aware of the risks involved, including the risks pertaining to the business and financial condition of the issuer of the underlying stock. Listed options are not suitable for all investors. Prior to buying or selling an exchange traded option, a person must be provided with, and review, a copy of CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS. A copy of this document may be obtained from the RBC Wealth Management Compliance Department, 60 South Sixth Street, Mpls., MN 55402 Phone: (612) 371-2964. Additional supporting documentation including statistics and other technical data are available upon request. RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC. © 2018 All rights reserved. 7101 (11/18).