Let’s now examine this identical framework within the stock market context to strengthen our understanding of ‘Call Options’. For clarity, we shall temporarily set aside certain complexities of options trading and focus on the fundamental architecture of call option agreements.
Imagine an equity trading at Rs 85 per share. You receive an opportunity to acquire this same equity one month hence at a predetermined rate of Rs 95 per share, provided the share price on that date surpasses Rs 95. Would you exercise this privilege? Absolutely. This means that even should the equity trade at Rs 115 after one month, you retain the ability to purchase it at the lower Rs 95 rate.
Securing this privilege requires an upfront payment today, let’s say Rs 8. Should the share price exceed Rs 95, you may exercise your entitlement and acquire shares at the predetermined rate. However, should the share price remain at or beneath Rs 95, you need not exercise your privilege, forfeiting only the initial Rs 8 payment. This arrangement constitutes an Option Contract, specifically termed a ‘Call Option’.
Following this agreement’s establishment, three possible outcomes exist:
Scenario 1
The equity price appreciates, reaching Rs 115 per share:
Purchase price for equity: Rs 95
Premium remitted: Rs 8
Total expenditure: Rs 103
Current market valuation: Rs 115
Gain: Rs 115 – Rs 103 = Rs 12
Scenario 2
The equity price declines, dropping to Rs 75 per share:
Under these circumstances, purchasing equity at Rs 95 proves illogical because you would effectively expend Rs 103 (Rs 95 + Rs 8) for equity available at Rs 75 in the open market.
Scenario 3
The equity price remains unchanged at Rs 95 per share:
Should the equity maintain its original valuation, you would spend Rs 103 to acquire equity available at Rs 95. Consequently, you would decline exercising your entitlement to purchase equity at Rs 95.
By this stage, you should comprehend the fundamental principle underlying call options. Nevertheless, certain nuances remain unexplained, which we shall address in forthcoming sections.
Presently, understanding this proves essential: based upon our discussion thus far, purchasing a call option invariably makes commercial sense when anticipating appreciation in an equity’s price or any underlying asset.
Having addressed foundational concepts, let us explore options further and acquaint ourselves with associated terminology.
Here’s the formal definition of call option contracts:
“The call option buyer possesses the right, though not the obligation, to acquire an agreed quantity of a particular commodity or financial instrument (the underlying) from the option seller at a specified time (the expiration date) for a specified price (the strike price). The seller (or ‘writer’) bears the obligation to sell the commodity or financial instrument should the buyer elect to proceed. The buyer remits a fee (termed a premium) for this right”.
For those navigating the stock market through a stock broker or seeking guidance from a financial advisor, understanding call options represents a crucial component of equity investment strategies. Whether evaluating trading calls or employing a stock screener to identify potential opportunities, options contracts offer sophisticated mechanisms for capitalising on market movements.
Visit for comprehensive educational resources on options trading strategies and market analysis tools.
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