Call Options

11 Key excerpts on "Call Options"

• 

  eBook - ePub

  Financial Markets for Commodities

  • Joel Priolon(Author)
  • 2018(Publication Date)
  • Wiley-ISTE

    (Publisher)

  5 Options Markets

  Options have seen considerable growth since the 1970s and, today, are among the most widely exchanged financial contracts on markets around the world. The basic principles on which options are based are easy to understand. However, the pricing of options is a difficult exercise based on an advanced mathematical corpus. This is why certain technical developments related to this are dicsussed in the Appendix.

  5.1. The fundamental concepts

  An option is a financial contract that binds the issuer, or writer of the option and the holder of the option, who has acquired the buying rights (option to buy) or the selling rights (option to sell) for certain goods, at a certain date (or over a certain period), at a price fixed in advance. In other words, the holder of an option has the right to buy or sell but has no obligation to exercise this right. When the contract is created, the option writer receives a premium paid by their acquirer. At the time when they commit to an options contract, the role of the seller and the buyer are unambiguous; but, going forward, the buyer may cede their option without, however, becoming the writer. This is why, in the rest of this chapter and in order to remove certain ambiguities, we will talk of “the writer” and not of the “seller”. Similarly, we will talk of the “holder of the option”, rather than “the buyer”. However, the reader must be aware that in other essays and books, these operators are very often called simply “seller” or “buyer”.

  5.1.1. Characteristics of options and a glossary

  The vocabulary used when talking about options is quite particular. We have provided, below, a list of the most frequently used terms:

  • – call

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Introduction to Financial Mathematics

  With Computer Applications

  • Donald R. Chambers, Qin Lu(Authors)
  • 2021(Publication Date)
  • Chapman and Hall/CRC

    (Publisher)

  contracts are opportunities or rights to buy or sell. A call option confers on its owner the right to buy an underlying asset while a put option is the right to sell an underlying asset.

  1.5.1 The Mechanics and Terms of Options

  A call option gives the holder of that contract the right (but not the obligation) to buy an underlying asset by a certain future date (expiration or maturity date, T) for a certain price (strike price or exercise price, K). Note that a call option contract has two parties: a buyer (the holder of the long position, also called the call holder or owner) and a seller or writer (the holder of the short position). The entity selling or writing the call option is obligated to deliver the underlying asset at a price of K to the option holder at the option holder’s demand. The buyer of the call option also has the right to do nothing at the expiration date and to let the option expire.

  In competitive and frictionless markets, the holder of a call option on a share of stock may be viewed as having the following potential payoff at the expiration of the option:

  Call option payoff to a long position at expiration = Max (

  S T

  - K , 0 )

  (1.10)

  where S

  T

  , is the value of the stock at the expiration of the option. When the stock price at the expiration of the call, S

  T

  , is less than the strike or exercise price, K, the call expires worthlessly. If the stock price exceeds the strike price, the call holder may exercise the call and receive the economic value of the difference (S

  T

  −K).

  The holder of the short side of the call option has the payoff: −Max(S

  T

  − K

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Basic Finance

  An Introduction to Financial Institutions, Investments, and Management

  • Herbert Mayo, , , (Authors)
  • 2018(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  The owner of an option to buy stock does not have to buy the stock, nor does the owner of a right to sell stock have to sell the stock. This makes options different from futures contracts, discussed later in the next chapter. If you enter a futures contract, you must either close the position or meet the obligation. The rights to buy and sell stock are not the only options in finance. For example, many bonds are callable. Such a call feature is an example of an option because the firm has the right to call the bonds and retire them prior to maturity. Many business transactions involve options. For example, a landowner may sell to a developer an option to buy the land. The developer does not have to buy the land but has the right to purchase it. Options to buy stock are called warrants if they are issued by firms and calls if they are issued by individuals. A warrant or a call is the right to buy stock at a speci-fied price within a specified time period. Options to sell stock are called puts . A put is the right to sell stock at a specified price within a specified time period. In the jargon of option trading, the market price of the option is the premium . The price at which you may buy or sell the shares is called the strike price or exercise price , and the day on which the option expires is called the expiration date . A firm may also issue an option called a “right.” Rights are issued to current stockholders when the firm is issuing new shares. By exercising the rights and buy-ing new shares, current stockholders maintain their proportionate ownership in the company. Rights have a very short duration, such as four weeks, while a warrant may be outstanding for years. Since calls constitute the vast majority of options to buy stock, the remainder of this chapter is devoted to calls and the opposite option to sell stock, the put.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Fundamentals of Financial Instruments

  An Introduction to Stocks, Bonds, Foreign Exchange, and Derivatives

  • Sunil K. Parameswaran(Author)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 7 Options Contracts INTRODUCTION Forward and futures contracts, which we examined earlier, are commitment con-tracts. That is, once an agreement is reached to transact at a future point in time, noncompliance by either party would be tantamount to default. In other words, hav-ing committed to the transaction, the long – whom we have defined as the party who has agreed to acquire the underlying asset – must buy the asset by paying the pre-fixed price to the short. At the same time, the short is obliged to deliver the underlying asset in return for the payment. Now let us turn our attention to contracts that give the buyer the right to transact in the underlying asset. The difference between a right and an obligation is that a right needs to be exercised if it is in the interest of holders and need not be exercised if it is not beneficial for them. An obligation, on the other hand, mandates them to take the required action, irrespective of whether they stand to benefit or not. Contracts to transact at a future point in time, which give buyers the right to transact, are referred to as options contracts, for they are being conferred an option to perform. When it comes to bestowing a right, there are two possibilities. Buyers can be given the right to acquire the underlying asset or they can be given the right to sell the underlying asset. Consequently, there are two categories of options: Call Options and put options. A call option gives the buyers of the option the right to buy the underlying asset at a predecided price, whereas a put option gives them the right to sell the underlying asset at a pre-fixed price. The prespecified price in the contract is termed as the strike price or the exercise price. Let us first consider Call Options. Clearly, holders will exercise their right to pur-chase the underlying asset only if the prevailing spot price at the time of exercise is higher than the exercise price.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  The Options Edge

  An Intuitive Approach to Generating Consistent Profits for the Novice to the Experienced Practitioner

  • Michael C. Khouw, Mark W. Guthner(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  Chapter 1 What Is an Option, and How Do Options Work?

  An option is a contract to buy or sell any specific item, which is referred to as the underlying instrument, asset, or interest. As with all contracts, there are two parties involved. An option contract is an agreement that gives the buyer or owner of the contract the opportunity, but not an obligation, to buy or sell the underlying instrument at their discretion. The seller, on the other hand, has the obligation to perform the seller's end of the bargain should the buyer choose to exercise their right to transact under the terms of the agreement.

  The underlying instrument is commonly a financial instrument like a stock, an index of financial instruments, a basket of stocks such as an ETF, a bond or a currency. The underlying instrument does not have to be a financial instrument, however. An option may reference a physical good such as a commodity (oil, gas, gold, silver or copper) or an economic good such as electricity, water, or real estate, and so on. Since investors are interested in options as a means of pursuing certain financial and/or risk management objectives in their investment portfolios, this book will focus on options referencing financial assets, such as stocks and stock indexes. Rest assured that the principles underlying an option contract are universal. It is easy to take the concepts presented and apply them to other aspects of your economic life, be it the purchase or sale of real estate or the management of a business.

  The terms and conditions of an option contract must be very precise. The contract defines when, how, and at what price the contract will be executed. For options on financial assets, there are a number of standard terms the buyer and seller must agree upon. Fortunately, options listed on exchanges have standardized terms. This makes financial options liquid and easy to trade. Once you know the basic standardized terms of an option contract, you are good to go. Firstly, an option contract will establish the price of a trade, if a transaction were to occur. A transaction only occurs, if and only if, the owner of the option choses to exercise their right to transact. When an owner of an option exercises their right to transact, they make the demand that the seller of the option perform to the terms and conditions of the option contract. When a contract is exercised, the obligation is fulfilled and the contract is terminated. The price at which a trade occurs is known as the strike price. The contract multiplier defines the amount of stock or commodity transacted under the option agreement. For options on equities, the contract multiplier is typically 100. This means that a single option contract references 100 shares of stock. As a result, when the owner of a call option on a stock exercises their right, the option seller must deliver 100 shares of stock. Options do not last forever. The contract will define the length of time an option will remain effective. Should the buyer choose to exercise their right under the option agreement and transact, the buyer must do so within this window of time. The date upon which an option expires is known as the expiration date

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Trading Options Greeks

  How Time, Volatility, and Other Pricing Factors Drive Profits

  • Dan Passarelli(Author)
  • 2012(Publication Date)
  • Bloomberg Press

    (Publisher)

  PART I The Basics of Option Greeks CHAPTER 1 The Basics To understand how options work, one needs fi rst to understand what an option is. An option is a contract that gives its owner the right to buy or the right to sell a fi xed quantity of an underlying security at a speci fi c price within a certain time constraint. There are two types of options: calls and puts. A call gives the owner of the option the right to buy the underlying security. A put gives the owner of the option the right to sell the underlying security. As in any transaction, there are two parties to an option contract — a buyer and a seller. Contractual Rights and Obligations The option buyer is the party who owns the right inherent in the contract. The buyer is referred to as having a long position and may also be called the holder, or owner, of the option. The right doesn ’ t last forever. At some point the option will expire. At expiration, the owner may exercise the right or, if the option has no value to the holder, let it expire without exercising it. But he need not hold the option until expiration. Options are transferable — they can be traded intraday in much the same way as stock is traded. Because it ’ s uncertain what the underlying stock price of the option will be at expiration, much of the time this right has value before it expires. The uncertainty of stock prices, after all, is the raison d ’ être of the option market. A long position in an option contract, however, is fundamentally different from a long position in a stock. Owning corporate stock affords the shareholder ownership rights, which may include the right to vote in corporate affairs and the right to receive dividends. Owning an option represents strictly the right either to buy the stock or to sell it, depending 3 on whether it ’ s a call or a put. Option holders do not receive dividends that would be paid to the shareholders of the underlying stock, nor do they have voting rights.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Investing and trading strategies X3

  Day Trading Strategies, Options Trading for Beginners, Swing and Day Trading

  • George Graham(Author)
  • 2023(Publication Date)
  • Youcanprint

    (Publisher)

  This is an order set to sell an option when it gets to a certain price (the stop price). This order seeks to limit the exposure of an investor to the markets of a specific position.

  1. Assignment

  This is the notification to the seller of an option that a holder has exercised the option and that they have to fulfill their obligation of the contract they sold.

  1. Sell to Close

  If you are long on an option, you can sell to close it at any time before the date of expiry of the contract. You do not have to retain the position of the option until the date of expiry.

  1. Buy to Close

  If you are the seller of an option and you short an option, then you buy to close the given option at any time before the contract expires.

  1. Bid and Ask Price

  Just as is the case for any security, there must be ask and bid prices for options. The bid price is the maximum price the buyer is willing to buy an option contract. The ask price (the offer) is the minimum price a seller is willing to sell the option contract. The difference between the ask price and the bid price is referred to as bid/ask spread.

  1. At the Money (ATM)

  This is the put option or call that has a strike price equal to the current trading price of an underlying security.

  1. Types of Option Trades

  Generally, there are two main types of option trades: put and Call Options.

  1. Call Option

  A call option is a contract or agreement that gives the investor/holder the right—but not an obligation—to purchase an asset at a specified price within a specified time. The main difference is that the call option gives you the right to buy or call in the asset. When the price of the asset increases, you can gain a profit from a call.

  The writer of the call option, also referred to as the seller, has an obligation to sell the security/asset if the investor exercises the option. The seller receives a premium for taking on the risk associated with the obligation.

  1. Put Option

  This option gives a buyer the right to SELL an asset/security at a given strike price before the expiry date. The writer/seller of the option has an obligation to purchase the security/asset if the strike price is exercised.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  AARP Getting Started in Options

  • Michael C. Thomsett(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  When you buy a put, it is as though you are saying, “I am willing to pay the asked price to buy a contractual right. That right provides that I may sell 100 shares of the specified stock at the indicated price per share, at any time between my option purchase date and the specified deadline.” If the stock’s price falls below that level, you will be able to sell 100 shares above current market value. For example, let’s say that you buy a put option providing you with the right to sell 100 shares at $80 per share. Before the deadline, the stock’s market value falls to $70 per share. As the owner of a put, you have the right to sell 100 shares at the fixed price of $80, which is $10 per share above the current market value. You own the right but you are not obligated. For example, if your put granted you the right to sell 100 shares at $70 but the stock’s market price rose to $85 per share, you would not be required to sell at the fixed price. You could sell at the higher market price, which would be more profitable. The potential advantage to option buyers is found in the contractual rights that they acquire. These rights are central to the nature of options, and each option bought or sold is referred to as a contract. The Call Option A call is the right to buy 100 shares of stock at a fixed price per share, at any time between the purchase of the call and the specified future deadline. This time is limited. As a call buyer, you acquire the right, and as a call seller, you grant the right of the option to someone else. (See Figure 1.1.) Let’s walk through an illustration and apply both buying and selling as they relate to the call option. • Buyer of a call : When you buy a call, you hope that the stock will rise in value, because that will result in a corresponding increase in value for the call

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Quantum Trading

  Using Principles of Modern Physics to Forecast the Financial Markets

  • Fabio Oreste(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  At the beginning of the twentieth century, the options markets on stocks was already rich and lively, even though it was just an OTC market, which means it wasn't regulated by an options exchange. Brokers offered their clients the possibility to buy and sell options, but unlike today, those options showed a very strange pricing. Black and Scholes hadn't yet discovered their option pricing models (they weren't even born yet), and so, in the beginning there was a fixed price for both calls and puts. It wasn't important that 15 or 30 days were left until the expiration day of a period: the price was always the same. Option buyers and sellers didn't have any models to understand if an option price was fair or not. They had only a fixed price, which caused fewer problems than the ones experienced by a professional options trader today.

  Finally, in 1973, a stock exchange was created in Chicago where many stock options were listed. Prices were clear and certain, and the transactions were regulated. But at that early stage only Call Options were listed. Put options weren't available yet; traders needed to wait a few years before having the complete option system that we have today. At that time traders used synthetic positions to simulate a put, obtained by selling short the stock, and simultaneously purchasing a call.

  Options Characteristics

  You can create an option on whatever is exchanged between different counterparts. If the option's underlying is listed in a regulated market, then the option is a standard contract with an official quotation. You have two kinds of options: calls and puts. A call buyer purchases the right to take advantage of a rise in the underlying. A put buyer bets on the decline of the option's underlying price.

  Consequently we will review the definition of an option we already saw at the beginning of the chapter.

  An equity option is a contract that conveys to its holder the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) shares of the underlying security at a specified price (the strike price), on or before a given date (expiration day). After this given date, the option ceases to exist. The seller of an option is, in turn, obligated to sell (in the case of a call) or buy (in the case of a put) the shares to (or from) the buyer of the option at the specified price upon the buyer's request.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  R Programming for Actuarial Science

  • Peter McQuire, Alfred Kume(Authors)
  • 2023(Publication Date)
  • Wiley

    (Publisher)

  Peter McQuire and Alfred Kume. © 2024 John Wiley & Sons Ltd. Published 2024 by John Wiley & Sons Ltd. Companion Website: www.wiley.com/go/rprogramming.com. 586 33 Financial Options: Pricing, Characteristics, and Strategies price. If the option is to buy the underlying asset it is a call option; if the option is to sell the underlying asset it is a put option. Remark 33.1 Our discussions will generally involve Call Options throughout the chapter and leave calculations relating to put options for the reader’s self-study. There are various types and varieties of options. We will consider only European options, where the option to buy or sell exists only at the expiry date specified in the contract. (Com- pare this with American-style options where the owner of the option contract has the right to exercise the option at any time prior to the expiry date.) The asset (specified in the contract) to be bought or sold under the contract varies con- siderably; examples include stocks, bonds, currencies, commodities (such as gold, copper, milk, cattle), and financial indices. Let us first take a simple example (more realistic examples will be discussed later in the chapter). If you think the price of gold will rise considerably (compared to the average view of the market) you may consider buying a gold call option. This guarantees that you can buy an agreed quantity of gold at an agreed price (the “strike price”) at an agreed future date (the “expiry date”). If the current price at which you can buy a specified quantity of gold is £10 (this is known as the spot price) and the strike price under the option contract is £15, by buying this option, say for £0.50, you have the option to buy the gold for £15 at the expiry date of the option. If the price of gold at expiry has risen to £20 you can buy the gold at £15 and immediately sell it for £20, thus making a profit equal to £4.5. Options can be either exchange-traded or over the counter (“OTC”).

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Getting Started in Options

  • Michael C. Thomsett(Author)
  • 2005(Publication Date)
  • Wiley

    (Publisher)

  A common reaction is, “Are you sure? Is that legal?” or “How can you sell some- thing that you don’t own?” It is legal, and you can sell something before you buy it. This is done all the time in the stock market through a strategy known as short selling. An investor sells stock that he or she does not own, and later places a “buy” order, which closes the position. The same technique is used in the options mar- ket, and is far less complicated than selling stock short. Because options have no tangible value, becoming an option seller is fairly easy. A call seller grants the right to someone else—a buyer—to buy 100 shares of stock, at a fixed price per share and by a specified expiration date. For granting this right, the call seller is paid a pre- mium. As a call seller, you are paid for the sale but you must also be willing to deliver 100 shares of stock if the call buyer exercises the option. This strategy, the exact opposite of buying calls, has a different array of risks than those experienced by the call buyer. The great- est risk is that the option you sell could be exercised, and you would be re- quired to sell 100 shares of stock far below the current market value. When you operate as an option buyer, the decision to exercise or not is entirely up to you. But as a seller, that decision is always made by someone else. As an option seller, you can make or lose money in three different ways: 1. The market value of the underlying stock rises. In this instance, the value of the call rises as well. For a buyer, this is good news. But for the seller, the op- posite is true. If the buyer exercises the call, the 100 shares of stock have to be delivered by the option seller. In practice, this means you are required to pay the difference between the option’s striking price and the stock’s current market 22 CALLS AND PUTS: DEFINING THE FIELD OF PLAY prospectus a document de- signed to disclose all of the risk characteristics associated with a particular investment.

  Sign up to read

  Learn more about book