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Sunday, May 1, 2016

What Are Call Option Contracts And How To Trade In Them?

A call option is a derivative contract that gives you the right but not the obligation to buy (go long) a specified quantity of a security (a.k.a the underlying) at a pre-determined price on or before the contract expiry date. 

The pre-determined price at which the call option can be exercised is known as the option strike price. 


Option Premium. 

To buy a call option, one needs to make an upfront payment known as the option premium. This premium is simply the cost of buying an option contract and has to be incurred whether or not the option is ultimately exercised. This premium is payable by the buyer of the call option contract to the seller. The seller is often referred to as the option writer. 

Recommended Read: What Are Option Contracts?

Call options can have a particular security or a market index as the underlying. 

Note that option contracts are always net settled. 

How to Trade in Call Options? 

Call options give you the right (but not the obligation) to buy a particular security at the strike price. So if you have a view that the market price of a particular security will exceed the strike price on (or before) the contract expiry date (bullish view); you buy a call option by paying the option premium. 

If on the contract expiry date (assumed for the sake of simplicity; an option can be exercised even before expiry) the market price of the security exceeds the strike price, you exercise the option. Thus you buy the lot of securities at a price lower than the current market price; the difference between the current market price and the strike price being your gain (options being net-settled). 

Of course! From this gross profit you must deduct the premium earlier paid to arrive at your net profit from the transaction. 

It is important for you to note that you can both buy or sell (i.e write) an option contract. Thus, if you have a bearish view on a particular security, you can always write a call option on the given security and pocket the premium.

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