Introduction to Call Options
Earlier, we have learned that there are two different types of options contracts: Call option and Put option. So first, let us understand: What are Call options?
An option that conveys the right to buy something is called a call option.
It gives the option to buy a stock at a certain predetermined price, so the buyer would want the stock to go up. The call option buyer believes that the underlying stock will rise because if this happens, the buyer will be able to acquire the stock for a lower price and then sell it for a profit.
A call option writer believes that the underlying stock's price will drop relative to the option's strike price during the life of the option. That is how he or she can reap maximum profit.
A long call is simply the purchase of a call option. It is a Bullish Strategy.
When to use it?
When we expect the spot price to be more than the strike price, and we are bullish on market direction.
What will be the Maximum Loss?
The loss is limited to the extent of premium paid. And when will this situation arise? when on expiry the Spot Price < Strike Price.
And what will be the Maximum Profit when buying a Call?
Theoretically we can say that the profit is Unlimited as the market rallies. Profit will only occur when Spot Price > Strike Price.
The payoff from a long position in a call option can be given by this equation.
= Max (S – E, 0) – C
Where,
E = Strike price
S = Price of the underlying security at maturity/ Spot price
C = Call option premium
Trading is ZERO SUM GAME. Profit for one person will be loss for other and vice versa. So, let us discuss a short call now.
A short call is simply the selling of a call option. It is a Bearish Strategy.
When to use it?
When you expect the spot price is less than the strike price, that means a bearish view on the market direction.
What will be the Maximum Loss?
Theoretically we can say Unlimited as the market rises.
And this loss will arise when: Spot Price > Strike Price
And Maximum Profit is Limited to the extent of premium received which will occur when
Spot Price < Strike Price
The payoff from a short position in a call option
= Min (E - S, 0) + C
Where,
E = Strike price
S = Price of the underlying security at maturity
C = Call option premium
