Inside The World of Call Options

A call option gives the holder of the option the right to purchase a defined number of shares of the underlying stock/security at a fixed price. This type of option is labeled as "call" because a holder of a call option can call the stock from the writer. At this point the writer of the option is legally bound to selling the stock to the holder at the pre-defined price termed the strike price. When a holder of an option uses his/her right granted by the option contract, it is termed as exercising the option.

For example a call option gives a holder the right to buy 200 shares of XYZ stock for $70, where the holder can exercise this right by paying the writer of the option $14,000 ($70*200). A holder of this option can exercise this right at any time before the option expires or can simply not exercise this right thereby letting the option expire. Only the holder of this option has the right to exercise the option- the writer simply waits until either the option expires or is exercised.

In effect a call option to buy signifies that the holder is betting the writer that prices are going to rise- in other words, the holder is bullish. If prices do rise, the holder will exercise the right to buy at the lower strike price. Then the holder will sell the underlying security at the higher market price yielding a profit. However, the writer of the call option is betting that price of the underlying security is going to fall- this writer is bearish. If prices fall, the option would not be exercised and the seller (writer) would keep the premium money earned by the bet. Transfer of the security very rarely occurs in practice, rather the writer and holder simply settle any difference between the security's strike price and current market price.


Example Option: Buy 1 NKE April 60 calls @ 2

Buy or Sell	# of Contracts	Underlying Security	Expiration Date	Strike Price	Option Type	Premium
Buy	1	NKE	April	60	Call	2

• Buy or sell: This is defined whether a investor wants to be a holder(buyer) or a writer(seller).
• Number of contracts: In the above example there is 1 contract in the option. One contract equals 100 shares of stock. Option contracts are usually sold in round lot numbers meaning in 100 share increments.
• Security: This is the ticker symbol of the underlying security.
• Expiration date: This is the month that the option contracts expire.
• Strike price: This is the price in which the holder has the right to purchase the underlying security.
• Option Type: Call or Put (general option strategies are defined below)
• Premium: This is the premium that the holder would pay for the right to exercise the option if they so desire.

General Option Strategies:

Bullish	Buy Call Sell Put	Above Market Price
Bearish	Buy Put Sell Call	Below Market Price

How are options traded?
Options are unlike traditional investments such as stock, although the two have close ties. Stocks are issued by the underlying company and sold in the open market. Options are issued by the Options Clearing Corporation, which is regulated by the SEC. The OCC will set the terms of the options contract- the strike price, expiration date, premium, etc. The OCC tracks sellers and buyers while also guaranteeing the obligations of both parties in the contract.


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