Options are contracts that are bought, sold, and exercised like securities on an exchange market. They offer great opportunities for sophisticated traders willing to expand their horizons and diversify their portfolio significantly. In this article, we will discuss how options, specifically call options, work and examine what is meant by a short call option.
Call options are contracts in which two parties forge an agreement regarding the ownership of an underlying asset. An underlying asset, such as a certain amount of stock in a particular company, is the foundation for the entire options exchange.
The selling party offers to the buying party the legal privilege but not the obligation to purchase the underlying asset at the strike price. The strike price is a pre-determined rate that must be honored throughout the life of the options contract. It is the only price the buyer may purchase the option at should they choose to exercise. There are other policies as well.
For instance, the buying party must exercise the option before the expiration date. Both parties involved also agree upon the expiration date in advance. After the expiration date, the option becomes worthless—it cannot be exercised or even traded.
The buyer must pay the seller a fee for the option known as a premium. This becomes the investment principal and the loss in the trade is limited to this fee. If the buyer chooses not to exercise the option, he does not have to pay anything extra. That being said, he does not receive a refund on his original premium payment. This fee is the only risk involved when buying a call option.
So clearly there are two sides of the option. One person writes it and sells it. To them it is a short call option. This person receives the premium fee and will have to sell the underlying asset to the buyer in the event of exercise. The other party is the buyer. To them it is a long call option. This person purchases the legal right to buy the underlying asset and may choose to do so at any time prior to the expiration date. This person may lose their premium, but that is the extent of their risk. Return, however, is unlimited. If the market value of the underlying asset increases far above the strike price, the buying party can make quite a deal of money from the transaction.
The person writing and selling the call is said to be taking a short position. The person buying it, on the other hand, is taking a long position on the option. Therefore, a short call option is an option being sold. If they are sold “unprotected”, they also referred to as a “naked call.” The selling party may lose a lot of money if the asset’s market value rises a significant degree.
Ultimately, the stance you take on options will have to be a matter of preference, but just make sure you know what you’re doing before you begin. Good luck and happy trading.
Related Pages
Leave a Reply