Index Options Strategies

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Buying Index Calls

The index long call is the simplest strategy to use in index options trading and the implementation involves the purchase of an index call option.

The options trader employing the index long call strategy believes that the underlying index level will rise significantly above the call strike price within a certain period of time.

Unlimited Profit Potential

Since they can be no limit as to how high the index level can be at the option's expiration date, there is no limit to the maximum profit possible when implementing the index long call strategy.

The formula for calculating profit is given below:

• Maximum Profit = Unlimited
• Profit Achieved When Index Settlement Value > Index Call Strike Price + Premium Paid
• Profit = Index Settlement Value - Index Call Strike Price - Premium Paid

Limited Risk

Risk for the index long call strategy is capped and is equal to the price paid for the index call option no matter how low the index is trading on expiration date.

Breakeven Point(s)

The underlier price at which break-even is achieved for the index long call position can be calculated using the following formula.

• Breakeven Point = Index Call Strike Price + Premium Paid

Example

XYZ Index is a broad based index representative of the entire stock market and its value in June is 400. Believing that the broader market will advance in the near future, an options trader purchases an six-month index call with a strike price of $400 expiring in December for a quoted price of $4.50 per contract. With a contract multiplier of $100, the cost of the index call option comes to $450.

Suppose XYZ Index went up to 420 in December and the trader's DEC 400 XYZ index call expires in-the-money. At settlement value of 420, the DEC 400 XYZ index call option will possess an intrinsic value of $20 and exercising this option will give the trader a settlement amount of $2000 ($20 x $100 contract multiplier). Taking into account the cost of the option itself, which is $450, the trader's net profit comes to $1550.

Suppose XYZ Index dropped to 380 in December and the trader's DEC 400 XYZ index call expires out-of-the-money. At settlement value of 380, the DEC 400 XYZ index call option will expire worthless with zero intrinsic value. The trader's net loss is equal to the amount paid for the index call option which is $450.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).

Out-of-the-money Index Calls

Going long on out-of-the-money calls maybe cheaper but the call options have higher risk of expiring worthless.

In-the-money Index Calls

In-the-money calls are more expensive than out-of-the-money calls but less amount is paid for the option's time value.