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Key Takeaways
A call option gives the buyer the right, but not the obligation, to purchase an underlying asset at a set strike price before expiry, enabling leveraged upside with limited loss.
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When you buy a call option, your maximum loss is the premium paid, while your profit potential is theoretically unlimited if the underlying asset’s price rises significantly.
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Call option pricing depends on intrinsic value (when asset price > strike) and time value (time until expiry, implied volatility, among other factors), both influencing the premium.
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Traders use call options for bullish strategies, hedging or speculation, but must understand risks like time decay, premium loss and the obligation if roles are reversed (writing calls).
What is a Call Option?
A call option is a financial contract that gives the holder the right, but not the obligation, to buy a specific quantity of an underlying asset at a predetermined price, i.e. the strike price, before a given expiry date. Once the expiry date passes, the right to buy the underlying asset ceases to exist.
Call options are often used by investors to potentially profit from the price increase of an asset without actually owning the asset. If the asset’s price exceeds the strike price before or on the expiration date, the call option holder can choose to exercise the option and buy the asset at the lower strike price, realising a profit. However, if the asset’s price doesn’t reach or exceed the strike price by the expiration date, the call option may expire worthless, and the holder would lose the premium paid for the option.
A call option is a right to buy without an obligation, which means you can choose to execute an option contract when it is profitable.
A Guide To Call Buying Strategy
Traders buy call options when they are bullish on an underlying asset because it allows them to leverage. Let’s try to understand the situation with the help of an example.
Assume that the stocks of ABC company are selling at a spot price of ₹50. Now, you buy 100 contracts at ₹3 premium per contract and at a strike price of ₹55. Suppose that after 1 month, the shares are trading at ₹65. You will then stand to make a profit of ₹. Here is how.
Spot price - Strike price = ₹65 - ₹55 = ₹10
This is because you can notionally buy the stock at ₹55 as per the call option and then sell it in the spot market at ₹65.
Total notional gain = ₹10*100 = ₹1,000
Premium paid = ₹3*100 = 300
Total profit = (₹1,000-₹300) = ₹700
What is a Long Call Option?
A long call option strategy is a contract in which the investor can buy a call option, giving them the right (not an obligation) to buy an underlying asset at a set price, also known as the strike price, before a specific expiration date. This strategy is deployed with the expectation that the underlying asset’s price will rise. Also called the bullish strategy for all the right reasons, it makes profits only when the market goes up. Usually, the investor has to pay a premium to buy a long call option, and when the share price increases, investors can buy these options, considering the possibility of increased profits.
Long Call Option Example
Let's take an example to understand a long call option:
Suppose that you have been tracking the progress of company ABC over a couple of months, and the stock price of this company is 20 at the moment. Suppose that you are sure that the price of the company ABC stock will rise within the next four months, you choose to buy a call option with the strike price of 25 at an expiry date of four months at a premium of 5 per share. Options represent 100 shares, so your total cost or premium would be ₹500.
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Breakeven point: A stock price at expiry is greater than the strike price (25 in this case), and the premium paid by the investor will give the breakeven point. The breakeven price would be in this case (strike price + paid premium)
Breakeven = ₹25 + ₹5
= ₹30
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Upside Potential: The profit potential is enormous in case the stock price increases beyond the breakeven point, which is theoretically unlimited. In case the stock price of ABC increases to 70, the profit would be:
Profit = (Inc price - Strike price - Premium) X num of shares
= (₹70 - ₹25 - ₹5) X 100
= ₹4000
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Limited Risk: The maximum loss an investor can face is the premium paid. In this example, the most you can lose is ₹500 if the stock remains below the strike price of ₹25 by the expiry date.
What is a Short Call Option?
Now that we know what a long call option is, a short call option is just the opposite. In short call option trading, the option seller, also known as the writer, believes that the price of the stock will decrease in the future. This contract allows the holder the right to buy the underlying asset for the strike price by a pre-defined expiration date. This strategy is called bearish as it anticipates the underlying asset’s price to be stagnant or decrease. However, in a short call, the maximum profit is limited to the premium received.
Short Call Option Example
Let's take an example to understand a short call option:
Imagine you believe a company ABC’s stock, which is currently trading at 100, will not rise above 105 over the next four months, and you decide to call an option with a strike price of 105 expiring in four months.
You will receive a premium of 5 per share (short call options also represent 100 shares), so the total premium will be 500.
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Maximum Profit: The maximum profit that can be made in a short call option is the premium received. In this case, the most you can make is 500 if the stock remains below 105 until expiry.
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Breakeven: The breakeven point occurs when the stock price is equal to the strike price plus the premium received.
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Loss Potential: If the price of the stock rises significantly above the strike price, the loss can be huge, theoretically unlimited. In this case, if ABC’s stock price rises to 110, you would face a loss of:
Loss = (120 - 105 - 5) X 100
= 1000
What Is Leverage in a Call Option?
In the above example, if you’re going to buy the stocks, you will have to invest (₹50*100) or ₹5,000. Or, you have the option to buy call options at ₹300, i.e. 100 contracts at ₹3 per contract (₹3*100 = ₹300). You can benefit from the same number of shares by buying a call option with much less investment.
The profit potential is unlimited in both cases if the market continues to move in the current direction. But if we have to estimate the loss, it is limited to ₹300 with the call option. But if you buy only stocks, you can lose the entire investment if the market slides. In this case, the call option functioned as a hedge against market risks. You can also close your position and exit the trade with the call option.
ITM, ATM and OTM Call Options
Call options are further divided into types, i.e. In-the-Money (ITM), At-the-money (ATM) and Out of the Money (OTM).
In-the-money (ITM) call options are those where the market price is higher than the strike price.
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If the strike price and spot price are close, then the option is said to be at-the-money (ATM).
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The out-of-the-money (OTM) call option is one where the market price is lower than the strike price.
If the market price of Infosys is ₹1,000, then the ₹980 Call Option will be ITM, while the ₹1,020 Call Option will be OTM.
Factors Influencing the Price of the Call Option
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Intrinsic Value: This is the inherent value of the option based on the difference between the underlying asset price and the strike price. In-the-money call options (underlying price above strike) have positive intrinsic value, while out-of-the-money calls (underlying price below strike) have no intrinsic value. Higher intrinsic value generally leads to a higher premium.
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Time to Expiration: As the expiration date approaches, the time value of the option diminishes, lowering the premium. Options with longer time to expiration have more potential for the underlying asset to move in the buyer's favour, hence a higher premium.
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Implied Volatility: This reflects market expectations for future price movements of the underlying asset. Higher expected volatility leads to a higher premium, as it increases the chance of the option becoming profitable before expiry.
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Interest Rates: Higher interest rates generally increase call option premiums. The logic is that buying a call option is cheaper than buying the stock outright. The money not spent on the stock (the strike price) can be in a bank earning interest. When interest rates are higher, this "saved" interest is greater, making the call option more attractive and thus more valuable.
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Greek Values: These are metrics that measure the sensitivity of the option price to changes in various factors like the underlying asset price (delta), volatility (gamma), interest rates (rho), and time to expiration (theta). You can learn more about option Greeks here.
Significance of Time Value in a Call Option
As we saw earlier, the option premium is the price that the buyer pays the seller to get the right to buy without the obligation to buy. This option premium has two components: time value and intrinsic value.
Premium = Intrinsic Value + Time Value
The intrinsic value is the price profit, while the time value is based on the probability of the option becoming profitable. All ITM options will have intrinsic value and time value, while OTM options will only have time value.
Let us understand this with a call option example. Assume that Infosys is trading at ₹1,000. Let us look at various scenarios of call option strike prices and how the split of time value and intrinsic value is worked out.
|
Strike Price |
Premium |
Expiry |
ITM/OTM |
Intrinsic Value |
Time Value |
|
940 |
105 |
January 2018 |
ITM |
60 |
45 |
|
960 |
93 |
January 2018 |
ITM |
40 |
53 |
|
980 |
61 |
January 2018 |
ITM |
20 |
41 |
|
1,000 |
38 |
January 2018 |
ATM |
0 |
38 |
|
1,020 |
29 |
January 2018 |
OTM |
0 |
29 |
|
1,040 |
22 |
January 2018 |
OTM |
0 |
22 |
|
1,060 |
14 |
January 2018 |
OTM |
0 |
14 |
From the above table, it is clear that OTM call options only have time value, while ITM options have time value and intrinsic value.
Understanding Options Trading in India
Cash Settlement of Options
Index options are indeed cash settled; hence, you cannot demand a delivery of an index. Stock options (on individual stocks like TCS and Reliance), however, are mandatorily physically settled if they are ‘in the money’ (ITM) at the time of expiry as per a SEBI mandate introduced in October 2019. Simply put, this means if you are the buyer of an ITM call option, you must take the delivery of the actual shares and pay the full contract value, and if you are the seller, you must deliver the shares from your demat account.
Index Call Option and Stock Call Option
An index call option is the right to buy an index, and the profit/loss will depend on the movement in the index value. Thus, you have Nifty Calls, Nifty Bank calls, etc. Stock options are options on individual stocks. Thus, you have call options on Reliance Industries, Tata Motors, Infosys, etc. The principle of trading call options in both cases is the same. You buy a call option when you expect the price of the stock or index to go up.
Weekly and Monthly Call Options Expiry
Call options on stocks are available in near-month, mid-month and far-month contracts with expiry on the last Thursday of the month or on the previous day if it's a holiday. Call options on indices can have weekly, monthly, and even quarterly expiries.
The following indices have options with weekly expiry:
|
Index Name |
Monthly Expiry |
Weekly Expiry |
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Last Thursday of every month |
Last Thursday of the expiry period |
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Last Wednesday of every month |
No weekly expiry |
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Nifty Financial Services |
Last Tuesday of every month |
No weekly expiry |
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Last Monday of every month |
No weekly expiry |
|
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Last Friday of every month |
Last Friday of the expiry period |
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|
Last Monday of every month |
No weekly expiry |
If the designated day is a holiday, then the previous trading day is usually considered the expiry day.
European Call Option and American Call Option
A European option can only be exercised on the expiration date, while an American option can be exercised anytime up to its expiration date. Historically, stock options were American-style and index options were European-style, but now many options on individual stocks are also European-style, and both styles are still traded. For a European call option, the contract name may sometimes include a 'CE' to denote this specific style, but the presence of 'CE' is not a universal or definitive rule for all European options.
Note: At the end of the option contract’s name, if you see a ‘CE’, it denotes that the option is a call European option.
Final Words
Trading options is a useful option strategy to increase your market exposure without infusing lots of funds. As we have seen, options trading in India offers a good way to participate in the markets with limited risk. If the above information interests you, you can trade options on Angel One by opening a demat account online.
Trading options is a useful option strategy to increase your market exposure without infusing lots of funds. As we have seen, options trading in India offers a dynamic way to participate in the markets.
To recap the key concepts:
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Long Call Option: A bullish strategy where you buy the right to purchase an asset, limiting your maximum loss to the premium paid.
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Short Call Option: A bearish or neutral strategy where you sell an option to collect a premium, which becomes your maximum profit.
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Call Option Examples: Our examples illustrated how profit and loss are calculated for both buyers and sellers, depending on the stock's price at expiry.
If this information interests you, you can start your options trading journey with Angel One by opening a demat account online.