Q: Please Explain Call Options in Share Trading with a simple example? - Mr. Suresh Babu, Chennai - 600 017 Via E mail
A:A call option gives the holder (buyer / one who is long call), the right to buy specified quantity of the underlying asset (Share or Index) at the strike price on or before expiration date in case of American style option.
The seller (one who is short call) however, has the obligation to sell the underlying asset (Share or Index) if the buyer of the call option decides to exercise his / her option to buy.
An Example:
A share Trader buys one European call option on Stock 'AA' at the strike price of Rs. 3,600 at a premium of Rs. 100. If the market price of Stock 'AA' on the day of expiry is more than Rs. 3,600, the option will be exercised.
The share trader will earn profits once the share price crosses Rs. 3,700 (Strike Price + Premium i.e. Rs. 3,600+ Rs.100). Suppose stock price is Rs. 3,900, the option will be exercised & the trader will buy 1 share of Stock 'AA' from the seller of the option at Rs. 3,600 and sell it in the cash market at Rs 3,900 making a profit of Rs. 200 {(Spot price - Strike price) - Premium}.
The other scenario..!
If at the time of expiry stock price falls below Rs. 3,400 say suppose it touches Rs. 3,000, the buyer of the call option will choose not to exercise his option. In this case the investor loses the premium (Rs. 100), paid which shall be the profit earned by the seller of the call option.
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