As we know options are a derivative instrument and Call and Put are two types of options. Here, we’re going to emphasise on call options.
Buying a Call option gives the buyer an option to “BUY” underlying asset at an agreed upon price with an expiry date on this contract. So buyer wants price of an underlying asset to go up. On the contrary, since call option seller has agreed to sell underlying expects prices to fall.
To explain this in a layman’s term, lets taken a practical call options example. Imagine you want to buy a house and have shortlisted a house and a price with the current owner of the house. But you need a few days to arrange for the money to complete the purchase. In such a case, buyers often give the sellers, what we call “token money” which is essential a right to buy the house at the agreed price in a pre-determined period. In case the buyer defaults on his promise to complete the purchase in the agreed time period, then the seller will forfeit the token money and book the same as his income. This token money is nothing but a call option premium.
How are call options different from put options?
The fundamental difference between call options and put options is that call options give the buyer a RIGHT TO BUY the underlying asset whereas put options give the buyer a RIGHT TO SELL the underlying asset.
Points under consideration while trading call options
One can trade call option in lots only.
As in India, we have adapted European Options style, Expiry date is fixed viz. last Thursday of the month (in case Thursday is a trading holiday previous working day).
In the money call option – when the strike price is lower than the price of underlying asset.
At the money call option – when the strike price and price of underlying asset are identical.
Out of the money call option – when the strike price is above the price of underlying asset.
Just for reference, let’s assume share price of ABC Company is Rs. 100 and lot size of 50 units. Trader A has bought a call option of an ABC company of 100 strike price (agreed upon price). Now if on the day of expiry share price of ABC Company closes above Rs. 100. Buyer will have a positive payoff as long as the payoff received is greater than the premium paid for the option.
As we trade call option or any other stock market instrument with the sole purpose of making money. Important thing to understand is Payoff. Payoff and Profit isn’t the same thing. Pay off means premium of the desired option at the time of expiry. For calculating Profit, one needs to take investment from payoff.
Eg. Trader A has bought a call option of 100 strike price of ABC Company at Rs. 2. Premium of ABC Company at the time of expiry is 10 then, Payoff will be Rs. 10 but profit will be Rs. 8.
In the case of option writer (seller), if call expires below strike price meaning worthless then payoff is what he collects in terms of option premium.
A Call gives buyer an option to “BUY” underlying asset at an agreed upon price with an expiry date on this contract. Whereas, Put gives buyer an option to “SELL” at agree upon price with an expiry date on this contract.
Call buyer would want prices of the underlying to go up and put buyers would like to see prices of underlying falling.
A call buyer makes profit when price of an underlying asset is more than the strike price at expiry. A put buyer makes profit when price of an underlying asset is less than the strike price at expiry. You can get a complete visualisation of options payoffs on the SAMCO Option Payoff Value calculator.
There are some popular call option strategies
In Long Call strategy, trader buys a call option of an underlying which is already in his portfolio.
In Bull Spread strategy, trader creates a spread by buying in the money call option and selling out of the money call option.
In covered Call strategy, trader writes at the money call option of an underlying which he holds in portfolio.
As the say, in trading most important thing is price. Likewise while trading call option one must keep in mind what is fair value of call option? To check the fair value check SAMCO’s Option value calculator.
Everything comes at a price, like while buying stock we pay the price, brokerage and transaction charges. To calculate the brokerage while trading options, refer the brokerage calculator for options.
While trading call option full filling margin requirement is necessary. To check what margin is required to trade call option check SAMCO’s SPAN calculator.
Important Facts for Trading Options
Buying Call Options
Margin Applicable – None, however option premium is payable upfront.
Risk – Reward – Maximum Loss is restricted to the premium, whereas the maximum profit can be unlimited.
Selling Call Options
Margin Applicable – Premium is received by the seller and credited to ledger however margin is payable for holding the short position. Check the Margin requirements for writing options on the SAMCO Margin Calculator.
Risk – Reward – Maximum Profit is restricted to the premium, whereas the loss can be unlimited.