What is a Call Option?
Call options are fiscal contracts that provide the purchaser of the option the right, but not the duty, to purchase a stock, bonds, commodities, or other assets or security at a defined price over a certain time frame. When the prices of the underlying asset rise, the call purchaser profits.
Important key points
- A call is an options contract that allows the holder the rights, and not the obligation, to buy a specific amount of fundamental assets at a specific price at a given time span.
- The striking price is the stated price, and the expiry or time to maturity is the defined time during which a transaction is made.
- You must pay a premium to acquire a call option; this per-share price is the maximum loss you may incur on a call option.
- Call options can be bought for speculative interests or sold for income or tax administration; they can also be combined together to form spread or combinations schemes.
How does a Call Option work?
Call options are a form of hybrid contract that permits the holder the right, and not the duty, to buy a certain amount of shares at a fixed price (the option’s “strike price”). If the stock’s market price increases over the strike price of the option, the option buyer can exploit the option by purchasing at the trigger price and selling at the higher market price to seal in a profit.
Nonetheless, Options are just accessible for a brief duration. The options expire zero if the current price does not climb over the specified price within that time period.
Understanding Call Options
Consider that the underlying asset is a share of stock. The owner of a call option has the option to acquire 100 shares of a business at a certain price, termed as the strike price, until a certain date, referred to as the expiry date.
A simple call option contract, for instance, may offer the owner the right to buy ordinary shares of Google stock for $100 till the contract expires in 3 months. Traders can pick from a variety of expiry dates and strike prices. The price of the option contract rises when the value of Google stock rises, and vise – versa. The call purchaser can keep the contract until it expires, at which point they can either accept delivery of the 100 stock shares or sell the options agreement at any time well before the expiry date for the current market rate.
You must pay a premium in order to acquire a call option. It is the sum paid in exchange for the call option’s rights. If the fundamental asset falls below the strike price at expiry, the call purchaser loses the premium paid. This is the greatest amount of money lost.
If the present market value of the asset is higher than the strike price at expiration, the profit equals the price difference less the premium. This amount is then calculated by multiplying the no. of shares owned by the option buyer.
If Google is trading at $130 at expiration, the strike price of the option contract is $110, and the buyer paid $5 per share for the options, the profit is $130 – ($110 +$5) = $15. If the buyer purchased a single options contract, their profit is $1500 ($15 X 100 shares); if they purchased two contracts, their profit is $3000 ($15 X 200).
However, if Google is selling below $100 at expiration, the buyer will clearly not be able to acquire the stocks at $100 per unit, and the option will expire worthlessly. For every contract purchased, the buyer loses $2 per unit, or $200, but that’s it. That’s the joy of having choices: you just lose the premium if you don’t participate.