Debt Management and Leverage

Option contracts

Call options example

You did not buy the shares at $15 as you had the option to buy them at $10, so your gain is [($15-$10) x 1,000] – $1,000 = $4,000.

Therefore the options you bought for $1000 have produced a profit of $4,000. This is a percentage return of 400%.

This is a much higher return than you would have achieved if you just bought the Company B Ltd shares instead of the options, i.e. 400% versus 36%.

There can also be a downside.

If the Company B Ltd shares fall to $9, your options would fall in value. If Company B Ltd shares stay at $9 on the expiry date, the options will be worthless.

As it is an ‘option’ it does not mean you have to buy the shares at $10. If you don’t exercise the options, they will expire on the expiry date.

If you let the option expire you would have lost your $1,000, or 100% of your money. However, if you bought the Company B Ltd shares instead of the options you would only have lost $2/$11 = 18%. On an initial investment of $1,000 in Company B Ltd shares, this loss would be $180 rather than the full amount.