Transcript: CIBC Investor’s Edge — Options explained: calls and puts

[Title Name: CIBC Investor’s Edge employee.]

[Music plays.]

[CIBC logo. CIBC Investor’s Edge – Options explained: calls and puts]

[A phone is shown. It opens to show a bar graph and a line graph.]

[A CIBC Investor’s Edge employee stands and speaks to the camera.]

[An icon of a signed document. Above the icon: “Call options give us the right”. Beside it, an icon of a coin with arrows coming out in both directions, with the wording above: “to buy a stock”. Next, an icon of a calendar with the wording above: “in the future”. Finally, an icon of a dollar is shown, with the wording above: “for a strike price”.]

CIBC Investor’s Edge employee: Hello and welcome to Investor’s Edge. Now that we've gotten the terminology out of the way, let's piece everything together. Why would you buy a call option in the first place? Remember, call options give us the right to buy a stock in the future at a predetermined strike price.

[Graphic changes to just the icon of a signed document. Beside it: “Must have a positive”. The icon then changes to an icon of a tall building with an arrow up sign. As this changes, the wording changes to: “Must have (bullish) outlook for the company”. Icon of a gauge and above: “Risk of the trade”. Beside it, a new icon of a dollar with a curved arrow under it and the wording: “confined to the premium paid” above. Next, a new icon of a signed document, with the wording above: “to enter the contract”. All slide off screen. Icon of a signed document and an X through it has the wording above: “if the contract expires worthless”. Beside it, a dollar icon with the wording above: “loss limited to what was put in”.]

If we are going to do this, then we must have a positive or “bullish” outlook for the company. The risk associated with our trade is confined to the premium we paid to enter the contract. If the contract expires worthless, then the amount we lose is simply the amount we put in.

[A laptop is opened and shows a graph. The graph starts at $10 and goes up by $2 to end at $14. The phrase “call option strike price = $12” is shown. A graph line starts at $10, fluctuates and stops at $11 and is labelled: “Buy stock at $11”. The title of the graph indicates: “Buy 10 contracts (100 shares each) of XYZ $12 call option ($.95/contract = $950)”.]

Looking back at an earlier example, we now illustrate the call option payoff for buying ten contracts of the XYZ $12 call option for $0.95 per contract.

[The graph line continues up to $12 and is labelled “in the money”. A portion of the title is highlighted: $12 is labelled “option strike” and $.95 is then highlighted and is labelled “+ premium”. A dotted line at $12.95 is shown on the graph with all information above it shaded and is labelled “break even”.]

The option is not in the money until the underlying stock hits $12. The break even on the trade can be found by adding the option strike of $12 to the $0.95 premium that we paid. Therefore, the stock price must be above $12.95 at expiry for us to make a profit.

[The graph line then continues upward. That point is indicated by an arrow and is labelled: “$16.50”. Below the dotted line is indicated by an arrow and is labelled: “$12.95”. Below a line is drawn and “$3.55 x 1,000” is indicated. This line then changes to: “$3,550 Profit”. An arrow is drawn from this line, which is titled: “call option return = 374%” to the title with “$950” circled above the graph.]

Let’s say the stock closes at $16.50 on expiry. Our profit is calculated by subtracting our break-even price of $12.95 from the current stock price of $16.50 and multiplying it by our share exposure of 1,000. This gives us a profit of $3,550 on an investment of only $950.

[A new graph is shown that starts at $10 and goes up to $16 and is titled: “Purchase 1,000 shares of XYZ at $11”. The fluctuating graph line starts at $10 and continues to a point of $11 and is labelled: “buy stock at $11”. The graph line continues up to a $16.50 point. Beside the graph, the following: “$16,500 - $11,000 = $5,500 Profit” and is labelled “purchase return = 50%”.]

If, by comparison we purchase 1,000 shares of XYZ at $11, the same stock price of $16.50 would generate a return of $5,500 or 50% over that same period of time.

[A new graph is shown which starts at $5 and increases by $5 up to $20. The fluctuating graph line moves from $8 up to $18 and that point is labelled: “current stock price $18”. The graph is titled: “Buy 10 contracts of $15 put for $2/contract. Premium = 1,000 x $2 = $2,000”.]

So now that we’ve talked about calls, let’s illustrate a put option, which you would purchase if you have a bearish view on a particular company or you would like to buy insurance on some of your existing portfolio holdings. Here we have XYZ trading at $18. We buy ten contracts of the $15 put for $2 per contract.

[The graph then changes so it ends at $8 and this point is labelled as “$8 on expiry”. Beside the grid: “strike price” at $15. The area below the graph line indicates: “$15 strike price - $8 on expiry = $7 in the money”. These two points are indicated as dotted lines. The wording then changes to: “$7 in the money - $2 premium/contract = $5/contract = $5,000”.]

If the stock closes at $8 on expiry, it would be $7 in the money. So our profit would be $5 per contract or $5,000.

[The graph then changes to the strike price indicated with a dotted line at $15 and is labelled as “strike price”. The graph line moves up to a point that is labelled “$16.50 on expiry”. The area above the $15 is highlighted and labelled as “out of the money” which then changes to “worthless”. The $2,000 in the title is circled.]

Now, what would happen if the stock closed at $16.50 on expiry? The $15 put would be out of the money and therefore worthless. You would lose the $2,000 premium you initially paid.

There you have it. You now have a basic understanding of what options are and how they work. Thank you for watching.

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