Options are usually used for hedging purposes, but can be used for speculative purposes. That said, options typically cost a fraction of what the underlying shares would cost. The use of options is a form of leverage that allows an investor to place a bet on a stock without having to buy or sell the shares directly. If the market price of the underlying share changes in your favour, you can «exercise» the call option for a call buyer or buy the underlying share at the strike price. U.S. options allow the holder to exercise the option at any time until the expiry date. European options can only be exercised on the day of expiry. Essentially, the intrinsic value of a call option depends on whether or not that option is «in the money» – or whether or not the value of the safety value of that option is higher than the strike price. For example, if you bought a call option with an exercise price of $25 and the current value of the stock was $27, your option would be «in the money» because it is immediately in profit (you can exercise your contract and make a profit immediately). However, since «in money» contracts have a higher intrinsic value, they are more expensive, so you pay a higher premium for the call option. Conversely, «out of money» call options are options whose underlying asset is currently lower than the strike price, making the option a little riskier, but also cheaper. Essentially, a long call option strategy should be used if you are optimistic about a stock and think that the price of the shares will rise before the contract expires. For example, if you bought a long-term call option on a stock that trades at an exercise price of $50 to $49 per share, bet that the share price will exceed $50 (perhaps to trade at around $53 per share).
In this particular example, the long call you buy is «out of money» because the strike price is higher than the current market price of the stock – but because it is «out of money», it will be cheaper. This is a good strategy if you are very optimistic about a stock and think it will increase significantly in a certain amount of time. Some call option sellers do not own the stock and in this case take an infinite risk because the stock can rise forever. When their short call is assigned, they take a short inventory position. This is called «naked short calls.» This is something that is only allowed in certain brokerage accounts and requires higher trading approvals from your brokerage firm. Both types of contracts are put and call options, both of which can be bought to speculate on the direction of stocks or stock indices, or sold to generate income. For stock options, a single contract includes 100 shares of the underlying stock. The buyer of a call option attempts to make a profit if the price of the underlying asset reaches a price higher than the exercise price of the option. On the other hand, the seller of the call option hopes that the price of the asset will decrease or at least never increase as high as the exercise price of the option before it expires, in which case the money received for the sale of the option will be a pure profit. If the price of the underlying security does not exceed the strike price before it expires, it is not profitable for the option buyer to exercise the option and the option expires worthless or «out of money».
The buyer suffers a loss equal to the price paid for the call option. Alternatively, if the price of the underlying security exceeds the exercise price of the option, the buyer can exercise the option profitably. The buyer of a call option is called the owner. The holder acquires a call option in the hope that the price will increase above the strike price and before the expiry date. The profit realized is equal to the proceeds of the sale, less the strike price, premium and any transaction fees associated with the sale. If the price does not exceed the strike price, the buyer will not exercise the option. The buyer suffers a loss equal to the premium of the call option. Suppose ABC Company shares are sold for $40 and a call option contract with an exercise price of $40 and a one-month expiration costs $2. The buyer is optimistic about the rise in the share price and pays $200 for an ABC call option with an exercise price of $40. If ABC`s stock increases from $40 to $50, the buyer will receive a gross profit of $1,000 and a net profit of $800. If the stock ends between $20 and $22, the call option will still have some value, but overall, the trader will lose money. And below $20 per share, the option expires worthless and the call buyer loses the entire investment.
For a short call, you sell a call option at an «Out of the Money» strike price (in other words, higher than the current market value of the underlying stock or security). For example, if a stock is trading at $45 per share, you should ideally sell a call option at $48 per share. However, since you are selling a call option, you must sell the shares at the low purchase price and buy back the shares at the market price (unlike if you only buy a call option which reserves the right not to buy the share). The break-even point – at which the option starts making money, having intrinsic value or being in the currency – is $55 per share. This is the strike price of $50 plus the cost of $5 for the call. If the stock is trading between $50 and $55, the buyer would recoup some of the initial investment, but the option shows no net profit. Call option sellers, also known as authors, sell call options in the hope that they will become worthless on the expiration date. They make money by putting the bonuses (prizes) they are paid in their pockets. Your profit will be reduced or may even result in a net loss if the option buyer exercises their option profitably if the price of the underlying security rises above the exercise price of the option. Call options are sold in two ways: The call buyer has the right to buy a share at the strike price for a certain period of time. For this right, the buyer of the call pays a premium.
If the price of the underlying moves above the strike price, the option is worth money (it has intrinsic value). The buyer can sell the option at a profit (this is what many call buyers do) or exercise the option (get the shares of the person who wrote the option). A call option is a contract that gives the owner the option, but not the requirement, to purchase a particular underlying stock at a predetermined price (known as the «strike price») within a certain period of time (or «expiration»). .