Debt Management and Leverage

Option contracts

Call options example

For example, Company B Ltd is trading on the share market at $11; you buy 1,000 call options in Company B Ltd which give you the option to buy the shares at $10 each in 6 months.

The premium (price of the option) is $1000.

In 5 months’ time, Company B Ltd shares are $12 and you decide to exercise the option to buy at $10 each.

Your gain is [($12-$10) x 1,000] – $1000 = $1,000.

Alternatively, you could have sold your option to another buyer and taken the market price.

Let’s say that immediately prior to expiry in 6 months the Company B Ltd shares are worth $15.

The shares in Company B Ltd have gone up by $4, which is a percentage return of $4/$11 = 36%. Had you made an initial investment of $1,000 in Company B Ltd shares instead of the options, this gain would be $363.