• Types of Options – 1

    Buy Call Option

    Call options buyers get the right to buy an underlying index or security at a particular price (same as strike or exercise price) on a particular date (expiry date). The call writer has to sell the asset at that price if the call buyer exercises the option. As the call buyer owns the rights, there is no credit risk involved and he pays only the premium to buy the right.

    Buying call options are used to take long positions in the market as it bets for price increase in the short term future.

    • If the trader believes that the market index will definitely increase in the short term he will buy call options.
    • Suppose on 10th July 2011, Nifty is currently trading at 5600 and call premium of one Nifty call option with strike price 5700 and expiry date as 28th July 2011 is trading at Rs 50. Here the trader wants to take long position will buy the option at Rs 50 with the anticipation of upward movement in the Nifty index.
    • The premium will be traded based on the Nifty index and will increase if nifty index goes up and will decrease if nifty index goes down.
    • The final premium value at the end of expiry period will be decided based on the nifty index value at that time.
      • If at the end of expiry date Nifty index > Strike Price; Then the premium will be the difference between Nifty index and Strike Price (Premium = Nifty index – Strike Price).
      • If at the end of expiry date Nifty index <= Strike Price; Then the premium will be zero irrespective of the Nifty Index.
      • Most of the cases, the traders do not prefer to wait for expiry. They sell the premium at higher prices just like normal shares with the upward movement of nifty to book profits.

    Sell or Write Call Option

    Call options seller are obliged to sell an underlying index or security at a particular price (same as strike or exercise price) on a particular date (expiry date) if the buyer exercises the option. The call writer has no other choice except to sell the asset at that price if the call buyer exercises the option. As the call writer is obliged to sell if the buyer uses his right, there is significant credit risk involved and he has to pay huge margin amount to sell the call option premium.

    Selling call options are used to take Short positions in the market as it bets for price decrease or stable range bound price in the short term future.

    • If the trader believes that the market index will either decrease or stay range bound in a short range in the short term he will sell call options.
    • Suppose on 10th July 2011, Nifty is currently trading at 5600 and call premium of one Nifty call option with strike price 5700 and expiry date as 28th July 2011 is trading at Rs 50. Here the trader wants to bet on decrease or stable position will sell the option at Rs 50 with the anticipation of downward or range-bound movement in the Nifty index.
    • The premium will be traded based on the Nifty index and will increase if nifty index goes up and will decrease if nifty index goes down or stays below 5700.
    • The final premium value at the end of expiry period will be decided based on the nifty index value at that time.
      • If at the end of expiry date Nifty index > Strike Price; Then the premium will be the difference between Nifty index and Strike Price (Premium = Nifty index – Strike Price).
      • In this case, Call writer’s profit will be the difference between Rs 50 and the end premium.
      • If at the end of expiry date Nifty index <= Strike Price; Then the premium will be zero irrespective of the Nifty Index.
      • In this case, Call writer’s profit will be the initial premium or Rs 50.
      • Call writer will gain if the Nifty closes below 5750 at the time of expiry.
      • Most of the cases, the traders do not prefer to wait for expiry. As the expiry date comes close and the nifty stays below 5700, the premium decreases with time.
      • They square off the premium at lower prices just like normal shares with the favorable movement of nifty to book profits. It is similar as short selling.


Leave a Reply

Your email address will not be published. Required fields are marked *