Understanding Call Options and Illustrated Use with an Example

Cheeky Chat on Call Options

🤗 What's the lowdown on call options?

Call options are financial contracts that grant the buyer the right, but not the obligation, to purchase a stock, bond, commodity, or other asset or instrument at a specified price—known as the strike price—within a specific timeframe. Selling call options yields the premium for the seller.

📈 Why do folks dig call options?

Investors buy call options when they're keen on a particular asset's price going up. In this case, buying options is a bullish move. Call options provide leverage by allowing investors to speculate on an asset's growth potential at a lower cost.

🛑 When does the call option party stop?

The fun ends when the call option expires, or when the buyer chooses not to exercise the option. If the asset's price is below the strike price at expiration, the call option is worthless. The buyer will have lost the premium paid.

🤝 What happens when the seller sells a call option?

When a seller sells a call option, they receive a premium in return. The premium caps the seller's profit potential, as their maximum gain is limited to the premium received. However, the seller is obligated to sell the underlying asset to the buyer if the option is exercised and the asset's price is above the strike price.

📊 Key Factors Affecting Call Option Profitability

Asset price movements: Rising prices are good for call option buyers, while falling prices make options less valuable or even worthless.
Volatility: Higher volatility is beneficial for buyers, as it boosts the option's value, increasing the opportunity for profit. Conversely, decreasing volatility hurts long call positions.
Time to expiration: More time is advantageous for buyers, as it increases the chance for the underlying asset's price to rise. On the flip side, time decay erodes the option's value as expiration approaches.
Strike price and expiration date: The strike price, expiration date, and asset price at expiration determine whether the option is profitable. The call option needs to have a price above the strike price at expiration, or the option will expire worthless.
Premium paid: The premium is the maximum loss the buyer can incur, and the option must move sufficiently above the strike price to cover the premium before generating a profit.
Delta, Gamma, Vega, and Theta: These are sophisticated metrics that measure the relationship between the option's price and variations in the underlying asset's price, volatility, and time.

🤑 Bells and Whistles with Call Options

Call options can be used for a variety of purposes, such as generating income, speculation, and tax management. Options can be combined to create spread strategies that cap both the profit and loss from a transaction. Remember, though, the tax treatment for call options varies depending on the strategy and holding period.

💰 Examples of Call Options in Action

Imagine you believe Apple's stock will rise above $100, and you buy a call option that grants you the right to purchase Apple shares at $90 with a premium of $5. If Apple's stock price rises to $110, the call option is profitable, and you can exercise it to buy the shares at $90 and sell them at $110 for a profit of $20 per share ($25 profit per share after accounting for the $5 premium). Conversely, if Apple's stock price falls below $90, you can let the option expire worthless without losing more than the premium you paid.

Or, suppose you have 100 shares of Microsoft and wish to generate additional income. You might sell a call option with a strike price of $115 for a premium of $3 per share. Depending on Microsoft's price movement, you could increase your income while taking on some risk. If Microsoft rises above $115, you'll be obligated to sell your shares, but you'll have received the $3 premium for the option.

In the world of Decentralized Finance (DeFi), investors can trade call options for digital assets such as tokens, providing opportunities to speculate on their price growth potential.
Liquidity for call options on crypto assets can be found on several Defi platforms, allowing for seamless buying and selling of these financial contracts.
Trading call options for ico tokens, for instance, can offer high returns if the price of the token increases significantly within the contract's timeframe.