BBS: Channel 1(R) Communications [ATI 2400 v.42] 617-354-7077 Date: 02-18-93 (14:45) Number: 13468 To: KIRT MCALEXANDER Refer#: NONE From: JACK HOCH Read: NO Subj: OPTIONS REPOST 2 OF 3 Status: PUBLIC MSG Conf: Finance (52) Direction: FORWARD Now, in-the-money options are less risky because they already possess what is known as "intrinsic value". For instance, the DEC 55 calls in Case 1 are selling for $5« (really $5.50 x 100 = $550.00 plus commission per contract). The stock price of IBM is $60. One DEC 55 call contract gives you the right to buy 100 shares of IBM at $55.00 between now and option expiration. So, if the stock is at $60, you could immediately exercise your DEC 55 call and buy 100 shares of IBM at 55! You could then sell the stock on the open market for $60.00/ share, immediately realizing a $5/share profit (minus commission). But, since you paid $550 (really $550.00 + commission) for the right to do this, you're actually out the commission and a little more. Even so, the option you're buying has an immediate "intrinsic value" of $5 per contract and is said to be "in the money". That extra $0.50 per contract you paid was the "time value" of the option. Out of the money options have no "intrinsic value". They are 100% "time value". Looking at Case 2 and assuming you bought the DEC 55 options as priced in Case 1, you see you've again lost some money, but not nearly as much as you would have percentage-wise had you bought the out-of-the-money 65 calls. In two weeks, the stock hasn't moved, and your options have declined in value from 5« to 5. The out of the money calls went from ¬ to 1/16 (worthless). Now in most cases, for EQUAL AMOUNTS of contracts purchased, your absolute loss is less with the out-of-the-money calls than with the in-the-money calls, but the percentage lost is greater. Again, I'm ignoring commissions. Out of the money: 4 DEC 65 contracts at ¬ initially cost you $100.00. After 2 weeks, this position is worthless. You've lost $100.00 which was 100% of your invested capital. In the money: 4 DEC 55 contracts at 5« initially cost you $2200.00. After two weeks the DEC 55 contracts are priced at 5. You've lost 4 x 100 x (5« - 5) = $200.00 which is only 9% of your invested capital. You can see your financial commitment was greater with in-the-money options and your absolute loss was greater, but your percentage loss was much smaller. You must be saying, "gee, with all the losing examples we've had, why would anyone want to buy call options"? Well below is an example of the plus side of it. The following table shows all December positions profitable at expiration: CASE 4: IBM last trade: $70.00, at Dec. expiration. Contract Price Contract Price Contract Price Dec 55 14 3/4 Jan 55 15« Mar 55 16 Dec 60 10 Jan 60 11 Mar 60 11« Dec 65 5 Jan 65 6« Mar 65 7« Remember those DEC 65 call options we bought for ¬ in Case 1? Well, they're worth 5 now! You can calculate the % gain on that one. The DEC 55s we bought at 5« in Case 1 are now worth 14 3/4! Another hefty gain! I'm assuming for this example that the stock price moved up 10 points in two weeks. That's a lot, but certainly not unheard of. Had it moved up a more modest 5 points in that amount of time, all the options would have been profitable except for the DEC 65s. Now, I haven't talked about the January or March series, but you can look at the tables and see for yourself how the option prices behave with regard to underlying stock price over time. When I buy options I tend to buy those contracts that are in-the-money and longer term. I'll be getting less leverage, but I'll also be reducing my risk. Personally, I still think there's plenty of leverage in options which are 4 to 6 months in length and 3 to 5 bucks in-the-money. In this example, had I bought one MAR 55 call in Case 1 (initial investment 7¬ x 100 = $725.00 before commission), with the stock moving up 5 points in two weeks (Case 3), I would have netted a profit of 11-7¬ = 3 3/4 x 100 = $375.00 before commission. Had I bought 100 shares of the stock instead, I would have made a $500 profit in the same amount of time, but on an investment of $6000! Monetary gain: option = $375.00 stock = $500.00 Percentage gain: option = 1100/725 x 100 = 52% stock = 6500/6000 x 100 = 8% >>>>>>>>>>>>> Continued >>>>>>>>>>>>>>