OPTIONS TRADING: CALL OPTIONS

CALL OPTION

As explained earlier, Call Option is an option where buyer gets the right to purchase the underlying but not any obligation. Buyer of the Call option expects the price to go up and hence purchase right to buy at a specified rate by paying premium. Call option buyer is getting the right to purchase from call option seller and pays the premium to call option seller. The Maximum loss to the buyer of the Option is limited up to premium paid. If price rises than Call buyer earns unlimited profit.  The maximum profit to the call seller is up to premium received when market falls and he may make unlimited loss if market rises. 

Example:

For Call Buyer

Mr. X has purchased the Nifty 24 June 2010, 5000 Call Option at Rs.200.

Here, Underlying is Nifty. || Strike Price is 5000. || Option is Call Option (Right to Purchase). || Maturity (Expiry) is 24 June 2010. || Premium is Rs.200.

So when spot price goes up above 5000, Mr. X will exercise his right to purchase Nifty at 5000. So he will get benefit when market rises above 5000. So if Market goes up to 5100 he will get Rs.100 back but as he has paid Rs.200 as premium so his net loss would be Rs.100. 

Now when market moves the payoff of buyer is as follows:

Pay-off for Call buyer

Spot Price	Pay-off
4600	-200
4700	-200
4800	-200
4900	-200
5000	-200
5100	-100
5200	0
5300	100
5400	200
5500	300

  

For Call Seller

Now suppose Mr. X has sold the above option. Now his maximum profit is up to premium he received and his loss is unlimited. Now when market moves the payoff of seller is as follows:

Payoff for Call Seller

Spot Price	Pay-off
4600	200
4700	200
4800	200
4900	200
5000	200
5100	100
5200	0
5300	-100
5400	-200
5500	-300

 

 

Break Even Point (BEP) for Call Option

BEP is a point when Options seller and buyer arrive at no profit and no loss situation. It is the price where trader is neither earning nor losing any money. Here, both buyer and seller remain at cost to cost. 

For call option BEP = Strike price + premium.

In above both example,   5000 + 200 = 5200. (Strike + Premium)

That means, when spot reaches 5200, Mr. X neither earns nor loses any money.