Options Contracts is one of the types of derivatives . In the Options Contracts have further two types call option and put option , right now we will discuss about Call option. A call option is an agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period.The seller (or “writer”) is obligated to sell the commodity or financial instrument to the buyer if the buyer so decides. The buyer pays a fee (called a premium) for this right.When a call option is bought, you are buying the right to buy a stock at the strike price, regardless of the stock price in the future before the expiration date. To compensate for the risk taken, the buyer pays a premium fee, also known as the price of the call. The seller of the call is said to have shorted the call option, and keeps the premium (the amount the buyer pays to buy the option) whether or not the buyer ever exercises the option.
When trading in options you should be very careful and you should know about the following three characteristics :
- Strike Price: The price at which an investor buys their stock (if call option is bought) and the price at which stock is sold (if call option is sold)
- Expiry Date: The date where the option expires if the buyer does not exercise it.
- Premium: The price paid when one buys an option and the price received when an option is sold.
The following is an example of call options but one can learn how to trade in Call option is by just keeping the three key factors in mind(Strike Price,Expiry Date,Premium). Suppose you exercise your call option after the earnings report, you use your right to buy 100 shares of ABC stock at $40 each and can sell them immediately in the open market for $50 a share. This gives you a profit of $10 per share. As each call option contract covers 100 shares(quantity(this quantity will vary)), the total amount you will receive from the exercise is $1000.
Suppose $200 was paid to purchase the call option, the net profit for the entire trade is $800. On a related note, in this scenario, the call buying strategy’s rate of interest (ROI) of 400% is very much higher than the 25% ROI achieved if you were to purchase the stock itself.Instead of purchasing call options, one can also sell (write) them for a profit. Call option writers, also known as sellers, sell call options with the hope that they expire worthless so that they can pocket the premiums. Selling calls, or short call, involves more risk but can also be very profitable when done properly. One can sell covered calls or naked / uncovered calls.The short call is covered if the call option writer owns the obligated quantity of the underlying security. The covered call is a popular option strategy that enables the stockowner to generate additional income from their stock holdings thru periodic selling of call options. When the option trader write calls without owning the obligated holding of the underlying security, he is shorting the calls naked. Naked short selling of calls is a highly risky option strategy and is not recommended for the novice trader.A callspread is an options strategy in which equal number of call option contracts are bought and sold simultaneously on the same underlying security but with different strike prices and/or expiration dates. Call spreads limit the option trader’s maximum loss at the expense of capping his potential profit at the same time.