Call option

Call Option Definition

A collection gives the buyer the right the buyer the right but not the obligation to buy an underlying asset at the strike price on or before the expiry date.The buyer of a call option speculates that the market is bullish and the prices of the underlying asset will increase. If at the expiry date the price the underlying asset is below the strike price the buyer refuse to exercise his right.His loss is limited to the premium paid. If  the price of underlying asset is above the strike price the profit is current stock price minus the strike price, multiples by the lot size,with premium deducted as a cost of the call option.

Call options are financial contracts that give the option buyer the right but not the obligation to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.

A call option may be contrasted with a put option, which gives the holder the right to sell the underlying asset at a specified price on or before expiration increase.

Types of Call Options

There are two types of call options as described below.

• Long call option: A long call option is, simply, your standard call option in which the buyer has the right, but not the obligation, to buy a stock at a strike price in the future. The advantage of a long call is that it allows you to plan ahead to purchase a stock at a cheaper price. For example, you might purchase a long call option in anticipation of a newsworthy event, say a company's earnings call. While the profits on a long call option may be unlimited, the losses are limited to premiums. Thus, even if the company does not report a positive earnings beat (or one that does not meet market expectations) and the price of its shares decline, the maximum losses that the buyer of a call option will bear are limited to the premiums paid for the option.
• Short call option: As its name indicates, a short call option is the opposite of a long call option. In a short call option, the seller promises to sell their shares at a fixed strike price in the future. Short call options are mainly used for covered call by the option seller, or call options in which the seller already owns the underlying stock for their options. The call helps contain the losses that they might suffer if the trade does not go their way. For example, their losses would multiply if the call were uncovered (i.e., they did not own the underlying stock for their option) and the stock appreciated significantly in price.

Using options for income

Some investors use call options to generate income through a covered call  strategy. This strategy involves owning an underlying stock while at the same time writing a call option, or giving someone else the right to buy your stock. The investor collects the option premium and hopes the option expires worthless (below strike price). This strategy generates additional income for the investor but can also limit profit potential if the underlying stock price rises sharply.

Covered calls work because if the stock rises above the strike price, the option buyer will exercise their right to buy the stock at the lower strike price. This means the option writer doesn't profit from the stock's movement above the strike price. The options writer's maximum profit on the option is the premium received.

Is call option better than stock?

Options can be a better choice when you want to limit risk to a certain amount. Options can allow you to earn a stock-like return while investing less money, so they can be a way to limit your risk within certain bounds. Options can be a useful strategy when you're an advanced investor.

How does call option work?

Call options are financial contracts that give the option buyer the right but not the obligation to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset.

Why does call option goes down?

If the stock closes below the strike price and a call option has not been exercised by the expiration date, it expires worthless and the buyer no longer has the right to buy the underlying asset and the buyer loses the premium he or she paid for the option.

Example of a Call Option

Suppose that Microsoft stock is trading at $108 per share. You own 100 shares of the stock and want to generate an income above and beyond the stock's dividend. You also believe that shares are unlikely to rise above $115.00 per share over the next month.

You take a look at the call options for the following month and see that there's a $115.00 call trading at $0.37 per contract. So, you sell one call option and collect the $37 premium ($0.37 x 100 shares), representing a roughly 4% annualized income.

If the stock rises above $115.00, the option buyer will exercise the option, and you will have to deliver the 100 shares of stock at $115.00 per share. You still generated a profit of $7.00 per share, but you will have missed out on any upside above $115.00. If the stock doesn't rise above $115.00, you keep the shares and the $37 in premium income.