Basics of Call Option & How it Works

Basics of Call Option & How it works

In derivative trading, if you want to trade in shares, then you can buy or sell them at a future date using the call options or put options. But what are call options and how do they work? Here is everything you need to know about the call option and how you can use it for trading.

What is an Option?

An Option is a derivative. It gives the right to the Option buyer to buy or sell an underlying asset at a specified price and date in the future.

What is a Call Option?

A Call option gives a buyer the right to buy a share. It is only a right and there is no obligation. If you have a call option on ITC, then you get the right to buy the shares by ITC but no obligation to buy them. For a call option, you need to pay a premium. Let us understand call option trading with an example.

Let’s consider you have bought ITC 1-month Rs 3000 call option at a price of Rs. 50. On the day of settlement, the price for ITC is Rs 3500 then here the option is profitable for you as you bought it at a lower price than the current price. On the contrary, if the price of ITC call option on the settlement day is Rs 2500 then you have the option to not buy it. The only obligation left here is to pay the premium price of Rs 50. This can be termed as your sunk cost.

When does one generally buy Call Options?

In any kind of trading, it is important that you time your trade properly. Same is the case with derivative trading. As there are multiple options, the question arises as to when you should buy a call option.

Generally, if you want to maximize your profits then you should buy at lows and plan to sell at highs. A call option gives you the option to fix the buying price. This is an indicator that you as an investor is expecting that there will be a possible rise in the price of the underlying asset. So, if you are a smart trader than you would want to protect yourself by paying just the premium. This saves you from any losses in the future. Hence you predict a rise in the stock market, i.e. when it is bullish.

How to settle a Call Option?

When you buy or sell an option then you can exit your position before the option expires or you can hold the position until it expires. If you want to exit before the expiry, then you can do it through an offsetting trade. Later the clearing house will settle the trade.

What influences the price of Call Options?

There are many factors which influence the price of the call option. Of these the strike price and the market price are the prime factors. Other than that political events, cuts in interest rates etc can also affect the price negatively.

Call options or option trading can give you a head start in stock market trading in India.

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