← Strategy LabLesson 15 · 3:55
Deep in-the-money stock replacement
Summary
Use a deep in-the-money call when you think XYZ will rise and want almost all of the shares' move for a fifth of the money: buy the $80 call for $20.04, $2,004 instead of $10,000 for 100 shares. The gain has no limit above, and the most you can lose is the $2,004, which happens if XYZ falls 20% to $80. You break even at $100.04, 4 cents above the current price.
Key terms
- stock replacement
- Using a deep in-the-money call to stand in for 100 shares.
- deep in the money
- An option whose stock price is far past the strike, with little time value left.
- intrinsic value
- The part of an option's price you could collect right now by using it.
- time value
- The rest of an option's price, paid for the chance things get better before the end, and gone by the last day.
- delta
- How much an option's price moves for a $1 move in the stock, and a rough guide to the chance it finishes in the money.
- break-even
- The stock price on the last day where you neither make nor lose money: strike plus premium for a call, strike minus premium for a put.
- dividends
- Deep in-the-money stock replacement
- Buying a call with a strike far below the current price so it moves almost like 100 shares for a fraction of the cost.
Check yourself
Answer each question to see why the right answer is right.
1. Of the $20.04 call price, how much is time value?
2. XYZ ends at $110. What does the $80 call make?
3. XYZ ends at $80, a 20% fall. What happens to the call?
4. Where does the call break even on the last day?
5. Why does time cost this call very little?
Finished the video and the quiz? .