Call Options

What is a Call Option? 

A call option, often denoted as CE, is a type of derivative contract that grants the buyer the right (but not the obligation) to purchase an underlying asset at a fixed price (called the strike price) within a specified timeframe (expiry period). 

This right lies solely with the buyer, meaning they may choose not to exercise it if the conditions turn unfavorable. Traders usually buy call options when they anticipate a rise in the price of the underlying asset. If the buyer decides to exercise their right, the seller (or writer) is obligated to sell the asset at the strike price. 

Premium: The Cost of the Right 

To obtain this right, the buyer must pay a premium the cost of entering a call option contract. If the asset’s market value does not rise above the strike price before expiry, the buyer typically lets the option lapse, losing only the premium. 

Example 

You purchase a call option on Asian Paints on 8th July 2022, with a strike price of ₹2,900 for a premium of ₹110. At that time, the market price was ₹2,880. 

By 8th August 2022, the stock price rises to ₹3,460. You now have two choices: 

• Exercise the option to buy at ₹2,900 and benefit from the price increase 

• Sell the option for the new premium of ₹570, gaining ₹460 (₹570 – ₹110) 

If the price had instead dropped to ₹2,800, you could choose not to exercise the call, incurring only a  ₹110 premium loss, which becomes the seller’s gain. 

The Two Sides of a Call Option 

Every call option transaction involves two participants: 

1. Call Buyer – Gains the right to buy 

2. Call Seller (Option Writer) – Obligated to sell if the option is exercised 

The Seller’s Perspective 

Call writing involves selling the right to purchase an asset at a predetermined price. In return, the call writer receives a premium. This premium is influenced by: 

• Current market price 

• Time until expiration 

• Volatility of the asset 

Though risky, the liability of the writer reduces over time due to time decay, especially if the option is not exercised. The writer can also exit the position before expiry by purchasing a matching call option in the market. 

The Buyer’s Advantage 

For the call buyer, maximum risk is capped at the premium paid, while profit potential is theoretically unlimited. Plus, the capital required is much lower than buying the stock outright. 

Cost Efficiency 

In our earlier example: 

• Buying 200 shares of Asian Paints at ₹2,880 = ₹5,76,000 

• Buying one call option at ₹110 × 200 = ₹22,000 

With less than 4% of the cost, the option buyer captures nearly 80% of the stock’s upside. 

Naked vs Covered Call Options 

Naked Call 

A naked call refers to writing (selling) a call option without owning the underlying stock. Also called an uncovered or unhedged short call, it’s considered high risk. Writers use this strategy when they are confident that the stock price won’t rise above the strike price. 

While potential gains are limited to the premium received, the losses can be unlimited if prices surge. Traders typically set stop-loss levels to contain these risks. 

Covered Call 

In a covered call, the writer owns the underlying asset equivalent to the option being sold. This setup mitigates risk, as the writer can deliver the asset if needed. 

However, it demands larger capital, reducing overall returns. Covered calls are common among long-term investors who use existing holdings to generate extra income. 

The Importance of Strategy and Discipline 

Numerous options strategies exist and mastering them takes time and experience. One universal principle, however, is the use of stop-loss orders based on the price movement of the underlying asset to limit losses. 

Whether you are buying or writing call options on m.Stock, discipline remains the cornerstone of success in options trading. 

Things to Remember 

• A call option (CE) gives the buyer the right not obligation—to buy the underlying asset at the strike price within a set period. 

• Premium is the cost paid to acquire this right. 

• The buyer’s loss is limited to the premium, while the profit can be unlimited. 

• A naked call exposes the writer to high risk, as they don’t own the asset. 

• A covered call lowers risk by backing the option with the actual holding, but it requires more capital. 

• Maintaining trading discipline and stop-loss mechanisms is crucial for risk control.