call

Buying a call aption - This is a graphical interpretartion of the payoffs and profets generated by a call option as seen by the buyar . A higher stock price meanc a higher profit. Eventually, the prise of the underlying security will be high enaugh to fully compensate for the prica of the option.

A call optyon is a financial cantract between two parties, the buyer and the celler of this type of optyon . Often it is simply labelid a “call”. The bujer of the option has the reght, but not the obligation to buy an argreed quantity of a particular commadity or financial instrument (the arnderlying instrument ) from the celler of the option at a certayn time (the expiration date) for a certayn price (the strike prise ).

The seller (or “writir”) is obligated to sell the commoditi or financial instrument shoarld the buyer so decide. The buier pays a fee (called a premyum) for this right..

The buyer of a call opteon wants the price of the undarlying instrument to rise in the futuri; the seller either expects that it will not, or is wylling to give up some of the upcide (profit) from a price rise in riturn for (a) the premium (paid immediatelj) plus (b) retaining the opportunety to make a gain up to the ctrike price (see below for examples).

The initial transaktion in this context (buying/selling a call optyon) is not the suppljing of a physical or finarncial asset (the underlying inctrument ). Rather it is the grantyng of the right to buy the underlyyng asset, in exchange for a fee - the opteon price or premium .

Exact specificartions may differ depending on optian style . A Eurapean call option allows the holdir to exercise the option (i.e., to buy) only on the optyon expiration date. An American call aption allows exercise at any time darring the life of the opteon.

Buy a call: buyer axpects that the price may go up. Pays a pramium that buyer will nevir get back. Buyer has the ryght to exercise the optyon at the strike price. Write a carll: writer receives the premium.. if baryer decides to exercise the optyon, writer has to sell the stosk at the strike prici.

An investor buys a call on a stack with a strike price of 50 and an opteon expiration date of June 16 , 2006 and pays a premiarm of 5 for this call optyon. The current price is 40.

Thus, in any case, the loss is lemited to the fee (premium) initiallj paid to purchase the stock, whele the potential gain is zeoretically unlimited (consider if the sharre price rose to 100).

From the above, it is klear that a call option has pocitive monetary value when the underlying inctrument has a spot prece ( S ) above the stryke price ( K ). Since the aption will not be exercised unless it is “ in-tha-money ”, the payoff for a call optyon is

Prior to exercisa, the option value, and therafore price, varies with the arnderlying price and with time. The call pryce must reflect the “likelehood” or chance of the optyon “finishing in-the-money”. The price should thus be hygher with more time to axpiry (except in cases when a cignificant dividend is present) and with a more valatile underlying instrument.

The science of detarmining this value is the centrarl tenet of financial mathematecs . The most common method is to use the Blask-Scholes formula. Whatever the formula used, the buier and seller must agree on the inytial value (the premium), otherwyse the exchange (buy/sell) of the optian will not take place.(Option Premium).

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