A Short Guide To Call Option (1)

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A Short Guide To Call Option
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• While there are numerous investment options
  available these days, one that took off by storm
  when launched was options trading in India.
  Considering their benefits such as leverage,
  ability to hedge, and high returns, many
  investors try their hand at it. Within it, there
  are call and put options which you can use to
  trade. Today, we will talk about the call option
  heres everything you need to know about them.

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The Call Option

• In the most basic sense, a call option is a
  contract wherein you the buyer have the right but
  not the obligation to purchase the particular
  commodity (derivative) at a specified price at a
  specified date. Now, let us try to understand
  this with an example.
• Say you are interested in buying 200 shares of
  Reliance Industries at INR 10 each. That makes
  the cost of the entire lot INR 2,000. You decide
  to enter into a call option with a trader
  (seller) which states that you will buy the 200
  shares exactly one month from the day the
  contract is signed. You have to pay a premium for
  this. Say you paid INR 200 as premium.

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• Remember, that you have the right to buy but not
  the obligation. Three scenarios will take place a
  month later
• Scenario 1 The price remains the same
• So exactly, one month after you signed the
  contract, the cost of the 200 Reliance
  Industries shares remain the same. No change at
  all. Technically one can say, its not profit
  or loss for you. But is it?
• You did pay INR 200 as premium.
• So Loss of INR 200 here.

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• Scenario 2 The price rises to INR 2,500
• This is advantageous to you. Why? Because while
  the price for the same lot in the open market
  is INR 2,500, thanks to the contract you
  entered into with the trader, you get to buy the
  lot for INR 2,000. So lets see.
• Original Price in contract INR 2, 000
• Premium INR 200
• So (2000200) INR 2,200 is total expenses
  incurred.
• Increased Price INR 2, 500
• So (2500 2200) INR 300 profit.
•  

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• Scenario 3 Price falls to INR 1,500
• When the price falls, it does not make sense to
  buy the stock especially when your total expense
  in INR 2,200.
• As you read, the call option provides the buyer
  with the right but not the obligation to buy the
  specified good at a fixed price at a fixed date.
  When used prudently, it can cause quite the gains.