A call option is a contract between two parties to transfer ownership of a stock at a specified price within a specified time period. A call option is also known simply as a ‘call.’ The price that the parties agree on is termed as the strike price. The date on which the agreement expires is called the expiration date of the call option. Though call options enable a buyer with the right to buy the underlying share, there is no obligation to buy it.
The seller of the contract is also known as the writer. The payment that is paid to the writer by the buyer of the call option is known as the premium.
Trading a Call Option
The specification of the trade may differ from exchange to exchange. They may also depend upon the option style. For instance, a US call option can be exercised at any point of time during life of a call option while a European call option can be exercised only on the expiration date.
Value of a Call Option
When the price of the underlying instrument goes up and gets closer to the strike price, that situation is most profitable for the buyer of the call options. When this price exceeds the strike price, the option is said to be ‘in the money.’
Strategies of Call Options
A covered call option refers to a strategy in which the seller of the call option is the owner of that underlying stock. So, the seller is provided a ‘cover’ by these shares in case the buyer of the option decides to buy the underlying instrument.
A naked call option is a highly risky and speculative strategy in which a speculator sells a call option on a stock without the actual ownership of that stock. The expectation of the speculator is that the price of the call option will increase. If it increases even by a dollar, the rate of return on the investment is very high. So, a naked call option is ranked among the riskiest strategies because the seller does not own the stock and is exposed to unlimited risk.
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