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What is call options in the stock market?

call option

 

 

Call options are a staple of the options market and are frequently used in a range of financial plans. A call option is a financial instrument that grants its holder the right, but not the responsibility, to purchase a particular amount of the underlying asset at a fixed price (the strike price) within a given time frame (the expiration date).

In order to potentially profit from the price increase without actually owning the item, speculators frequently employ call options to speculate on the underlying asset’s prospective rise in value. Before or on the expiration date, if the asset’s price rises above the strike price, the holder of the call option may elect to exercise the option and purchase the asset at the lower strike price, making a profit.

The holder of the call option would forfeit the premium they paid in case the asset’s price fails to hit or surpass the strike price by the option’s expiration date, rendering the option useless.

What is a call option?

An option contract that grants the buyer the right to acquire the underlying asset at a predefined price within the specified expiration period is known as a call option. A bond, shares, or other type of security is the underlying actual asset for a call option.

 

A few terms related to call option.

Strike Price: The amount that has previously been decided upon.

Exercise Date: The day when the right is realised.

Premium: The fee charged for the respective right

 

What is a long call option and a short call option?

A long call is the most prevalent stock call option strategy employed by investors while buying call options. It focuses on an underlying asset’s market price to increase substantially beyond the strike price before the expiration date. Investors have to pay a premium to buy a long call option. In the case of speculation about an increase in share prices, investors buy these options due to the possibility of improved profits. However, if the price drops below the strike price, option holders stand to lose the amount paid for the option agreement as well as the premium.

Whereas, a Short call option involves selling an option when an investor has to purchase a given underlying asset at a predetermined price. A short-call strategy leads to limited profit if shares are traded below the strike price and attract substantial risk if it is sold at a value exceeding its strike price. A short-call strategy is suitable to use when an underlying asset is anticipated to experience a moderate fall. This strategy will help generate upfront credit that may be effective in offsetting the margin

When to buy a call option?

If a security’s price increases before its exercise date, buying a call option may yield a profit to an investor. If there is indeed a rise in the value of a security, it should be bought at the strike price and immediately sold off at a higher market price. Holders of call options may also wait a little longer to discern the possibility of a further price rise. Such an option is not exercised if the price of securities fails to rise above the striking price. In such a situation, the investor will only suffer a loss of premium. This approach holds true even if the price of securities drops to zero.

In exercising a call option, profit or intrinsic value accruing to investors is the remainder of the security proceeds after deducting the striking price, call option premium, and any associated transactional fees. Buying a call option can be more lucrative than purchasing security because the former provides more leverage to the holder. In the case of a price rise, a holder stands to make substantial gains as opposed to only selling the security. Even if the price of securities plummets, an investor will only lose a fixed amount. It would restrict any further loss that an investor may otherwise incur. It leads to a generation of higher returns even for a lower investment. The investor may also sell off options with an increase in securities’ price It enables the investor to make a profit without even having to pay for securities.

When Should You Sell Call Option?

An Investor should sell a call option if there is a reason to believe that the price of assets may plummet. The premium amount can still be recovered if the asset’s price drops below the strike price.

There are two ways by which call options can be sold – naked call option and covered call option.

Naked Call Option: in this case, the holder sells the option in the absence of the involved asset’s ownership. It includes a significantly high risk because if a buyer decides to exercise an option, the seller will have to purchase the asset at market price to meet the order.

Sellers of the call option are exposed to enormous risk as there is no limit to an asset’s price, which may result in substantial loss. A seller thus usually charges such a fee that may offset the risk involved. Naked call options are usually exercised by big corporations, which can successfully diversify the risks.

Covered Call Option: In this case, an option is covered by an underlying asset. The seller already owns his/her asset and on selling this option, makes a risk-free profit from the premium charged for a call option. However, the seller does not benefit if the price of an asset experiences a sharp increase. Here, the holder cannot sell this option at an increased price. It can only be sold at the strike price.

Also Read : What is a put in the stock market?

What is the difference between a call and a put option?

Call option provides the option, to purchase the asset in question on a specified date at a predetermined strike price. Here, investors expect a price increase.

Whereas, a sell option provides the option, to sell an underlying asset on a specified date at a predetermined strike price. Here, the investors expect a fall in the price.

 

 

Please Note: Investments in the securities market are subject to market risks, read all the related documents carefully before investing.

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