Leverage buy using deep in-the-money calls


Longing deep in-the-money call is a great way to leverage. Let's use Nany Pelosi's recent trade (as shown below) to illustrate this concept.

At this time, the market price of PANW is about $\$310$ and the price of this $\$200$-strike call is about $\$120$. This means that this call has an intrinsic value of $\$110$ and a time value of $\$10$ which can be viewed as the financial cost of the leverage we are discussing here.

As this call option is deep in-the-money, the change in its price will be almost same as the change in the underlying stock (i.e., the delta of this call option is about $1$). This means that the profits and losses between holding this option and owning its underlying stocks are almost the same in an absolute term. The only difference is the leverage: Mrs Pelosi essentially paid a $\$120$ downpayment to control a stock valued at $\$310$, implying a leverage ratio of roughly $2.5:1$!



2018 FlexibleStudy. All rights reserved.