Options 2: Call Options
Call Options
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Call options give an investor he right (but not the obligation) to buy |
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The underlying stock;
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The Expiration Date; and
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The Strike Price.
As an example, lets say a investor in the US wishes to obtain the right to buy shares
in EBAY for the current market price for the next 6 months. Lets say this takes
place in December 2006, and shares in EBAY are currently selling for $130 on the
open market. The investor may purchase a call option that has an
expiration date of June 2007 and has a strike price
of $130. This would be known as an EBAY June 130 Call.
In order
to purchase this option the investor would pay an option premium which
is determined at market price, lets say it was $3 per share, and since this is a
US option contract there would be 100 shares in the contract and therefore the cost of each option contract would be $300.
Purchasing this option will allow the investor the right to purchase 100 shares
of EBAY stock for $130 at any time up to the expiration date regardless of the market
price of the stock. Therefore if the market price goes up to say $150, the investor
can exercise his option and buy the stock for $130 and sell it back to the market
at market price of $150, and pocket the profit of $20 per share or $2,000 per contract.
Alternatively the investor may wish to sell the option back to the market to close
his/her position rather than exercising it for stock, in which case the option premium
will now have risen dramatically since the option is what is known as In The
Money, i.e. the strike price is lower than the underlying stock price
and therefore it has intrinsic value. The investor can sell the
option back to the market at any time before expiration and profit from the rise
in the option premium.