What is a Call Option?
- 05 Jul 2024
- By: BlinkX Research Team
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Meaning of Call Option
A call option is a derivative contract granting the purchaser the right, yet not the obligation, to purchase a specified asset such as a stock, bond, or commodity at a predetermined price within a defined timeframe.
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Table of Content
- Meaning of Call Option
- Understanding Call Option?
- Call Option Example
- What is a Nifty 50 call option?
- What is the Nifty call put option?
- Difference between Call Option and Put Option
- When should you buy a Call Option?
- When should you sell the Call Option?
- Weekly Options and Monthly Options
Understanding Call Option?
A call option is a financial agreement that grants the buyer the privilege to acquire the underlying asset at a prearranged price before a specified expiry date. The underlying asset in a call option can include bonds, stocks, or other types of securities.
Below are key terms associated with this type of option:
Strike Price - The predetermined price
Exercise date – It refers to the date upon which the option holder may exercise their right.
Premium- It denotes the fee paid for the right to hold the option.
Call Option Example
Let’s understand the call option with an example:
Buy Call Option:
Assuming ABC Company stocks are currently trading at Rs. 100 per share, Investor C, holding 100 shares, seeks additional income beyond dividends. With expectations that the stock price won't exceed Rs. 120 next month, C explores call options and finds a Rs. 120 strike price call option trading at Rs. 0.40 per contract. C decides to sell one call option, receiving a premium of Rs. 40 (Rs. 0.40 x 100 shares).
If the stock price rises above Rs. 120, the option buyer may exercise their right, obligating C to sell the shares at Rs. 120 each. However, if the stock price remains at or below Rs. 120, B will retain ownership of the shares without executing a sale.
Long Call Option:
A long call is a popular strategy where investors buy call options, expecting the price of a stock to rise significantly above a specific level (called the strike price) before a set date.
When investors buy a long call option, they pay a fee, called a premium. They do this because they believe the stock's price will go up, potentially leading to higher profits. However, if the stock price doesn't go above the strike price by the expiration date, investors can lose the premium they paid.
For instance, let's say ABC company stock is priced at Rs. 50 per share. Investor Z buys a call option with a strike price of Rs. 55 that expires in one month, expecting ABC's price to rise to Rs. 55 by then. This call option gives Z the right to buy 100 shares of ABC at Rs. 55 each.
If the premium for the option is Rs. 2 per share (totaling Rs. 200 for 100 shares), that's the maximum amount Z could lose. If ABC's price climbs to Rs. 60 by expiration, Z can buy shares at Rs. 55 and immediately sell them at Rs. 60, making a profit of Rs. 5 per share. But if ABC's price stays below Rs. 55, the option expires worthless, and Z loses the Rs. 200 premium paid.
Short Call Option
Selling a short call option means the investor agrees to sell a specific stock at a set price, known as the strike price. This strategy works best if the investor thinks the stock price will stay the same or go down slightly.
For example, let's say stock ABC is priced at Rs. 50 per share. Investor Y expects the price to stay below Rs. 53 in the next month. Y decides to sell one call option with a Rs. 53 strike price that expires in a month. By selling this option, Y receives a premium of Rs. 2 per share, totaling Rs. 200.
If ABC's price remains below Rs. 53 by the expiration date, the option expires, and Y keeps the Rs. 200 premium as profit. But if ABC's price rises to Rs. 55, the buyer of the call option may choose to exercise it. Y would then have to sell the shares at Rs. 53, even though they are worth Rs. 55, resulting in a loss of Rs. 2 per share.
What is a Nifty 50 call option?
A Nifty 50 call option refers to a type of financial contract where the buyer has the right, but not the obligation, to purchase a specified amount of the Nifty 50 index at a predetermined price (strike price) within a specified period (until expiration). The nifty 50 call option allows investors to profit from potential price increases in the Nifty 50 index without needing to directly own the underlying stocks. If the Nifty 50 index rises above the strike price before expiration, the call option holder can exercise their right to buy at the lower strike price, potentially earning a profit from the difference.
What is the Nifty call put option?
A Nifty call put option refers to a financial derivative where investors can purchase or sell the Nifty 50 index at a predetermined price (strike price) within a specified time frame. Traders monitor the Nifty call put option price live to gauge market sentiment and make informed decisions on buying or selling these contracts based on real-time fluctuations in the underlying Nifty 50 index. Understanding the Nifty call put option price live is essential for managing risk and optimizing potential returns in response to current market conditions.
Investors use Nifty Call and Put Options in the share market for various strategies, including hedging against adverse price movements in the market, generating income through premiums by writing (selling) options, or purely speculating on market direction. The Nifty Call and Put Options price is influenced by factors such as the current price of the Nifty index, the strike price of the option, the time remaining until expiration (time value), volatility in the market, and prevailing interest rates.
Overall, Nifty Call and Put Options provide flexibility and leverage for investors seeking to manage risk or capitalize on market opportunities related to the Nifty 50 Index, offering a wide range of strategies to suit different market outlooks and risk tolerances.
Difference between Call Option and Put Option
Investors buy a put option when they expect the price of an asset to drop within a certain time. With a put option, the buyer can sell the asset at a set price before a specific date.
Buying a put option involves paying a fee called a premium. If the asset's price falls below the set price (called the strike price), the put option becomes valuable. At that point, the buyer can sell the option for a profit or wait until it expires to sell the asset at the strike price.
Let us check out a few basic differences between the two options
Call Option | Put Option |
| It allows you to buy an asset at a set price on a specific future date without having to do so. | It allows you to sell an asset at a set price on a specific future date without being required to do so. |
| Investors expect the price to go up. | Investors expect the price to fall |
| There is no limit to how much profit you can make because the price can rise indefinitely. | Profit is limited because if the price goes down, the maximum profit is capped at zero. |
When should you buy a Call Option?
When you buy a call option and the price of the stock goes up before the option expires, you can make a profit. You do this by buying the stock at the strike price and then selling it immediately at the higher market price. Call option holders can also wait to see if the price goes up even more.
If the stock market call price doesn't go above the strike price, the call option is not used. In that case, you only lose the money you paid for the option, called the premium. This is true even if the stock price drops to zero.
When you exercise an options call, your profit is the money you make after subtracting the strike price, the premium you paid for the option, and any fees.
Buying a call option can be more profitable than buying the stock itself because it gives you more potential gain for a smaller upfront investment. If the stock price goes up, you can make a lot of money compared to just selling the stock.
Even if the stock price goes down a lot, your loss is limited to the premium you paid for the option. This protects you from losing more money. Buying call options can lead to higher returns for a smaller initial investment. You can also sell the options if the stock price goes up, making a profit without ever owning the stock.
When should you sell the Call Option?
If the investor thinks the price of an asset might fall, he should sell a call option. He can still regain the premium paid if the asset's price drops below the strike price.
There are two ways to sell call options: naked call options and covered call options.
Naked Call Option
The holder sells the option without owning the underlying asset. This approach carries high risk because if the buyer chooses to exercise the option, the seller must buy the asset at the current market price to fulfill the obligation.
Sellers of naked options call face significant risk because there is no cap on how high the asset's price can go, potentially leading to large losses. To compensate for this risk, sellers typically charge a fee that accounts for the potential loss.
Naked call options are typically used by large corporations that can effectively manage and diversify their risks.
Covered Call Option
Here, the seller owns the underlying asset they are selling an option for. By selling this covered options call, they earn a premium, which is a risk-free profit. However, if the price of the asset rises sharply, the seller does not gain from that increase. The option can only be sold at the strike price agreed upon earlier.
Weekly Options and Monthly Options
Monthly call options expire on the last Thursday of each month and are commonly traded. Recently, SEBI and the exchanges introduced a new product called weekly options, specifically for the Bank Nifty Call Put Option Price. These options expire every week, aiming to reduce the risk associated with options trading.
