A call purchase is a type of transaction where a buyer agrees to buy an underlying asset, such as a stock, bond, commodity, or currency, at a specified price within a specified time period. The buyer pays a fee to the seller for this right, which is called the premium. The seller has the obligation to deliver the asset to the buyer if the buyer exercises the option.
A call purchase can be used for various purposes, such as speculating on the future price movement of an asset, hedging against potential losses, or generating income from selling options. A call purchase can also be combined with other options or strategies to create more complex and customized positions.
For example, suppose you are bullish on Apple’s shares and you expect them to rise above $150 in the next month. You can buy a call option with a strike price of $150 and an expiration date of one month from now. You pay $5 per share as the premium for this option. This means that you have the right to buy 100 shares of Apple at $150 per share anytime before or on the expiration date.
If Apple’s share price rises above $150 in one month, you can exercise your option and buy 100 shares at $150 per share. You will then own 100 shares of Apple at a lower price than the market value. You can sell these shares later at a higher price and make a profit.
If Apple’s share price stays below $150 in one month, your option will expire worthless and you will lose only the premium that you paid for it. You will not have to buy any shares of Apple at $150 per share.
If Apple’s share price falls below $150 in one month, your option will also expire worthless and you will lose only the premium that you paid for it. However, if you sold your option before it expired, you might be able to sell it at a higher price than what you paid for it in the market.
Basic Theory:
A call option consists of two key elements: the strike price and the expiration date. The strike price is the price at which the option holder can buy the underlying asset, while the expiration date is the date by which the option must be exercised. When an investor purchases a call option, they are essentially betting that the price of the underlying asset will rise above the strike price before the option expires.
Procedures:
- Identify the Underlying Asset: Determine the asset for which you want to purchase a call option.
- Select the Strike Price and Expiration Date: Choose a strike price and expiration date based on your market outlook and investment strategy.
- Evaluate Premium: The premium is the price you pay for the call option. Evaluate the premium based on factors such as volatility, time to expiration, and the difference between the current asset price and the strike price.
- Calculate Break-Even Point: Determine the price at which the underlying asset must reach for the call option to break even, considering the premium paid.
- Monitor Market Conditions: Keep track of market conditions and the performance of the underlying asset as the expiration date approaches.
Real-World Scenario:
Let’s consider a scenario where an investor purchases a call option for XYZ stock.
- Underlying Asset: XYZ Stock
- Current Stock Price: $50
- Strike Price: $55
- Premium Paid: $3
- Expiration Date: 3 months
| A | B | |
|---|---|---|
| 1 | Current Stock Price | $50 |
| 2 | Strike Price | $55 |
| 3 | Premium Paid | $3 |
| 4 | Expiration Date | 3 months |
| 5 | Break-Even Price | =B1+B3 |
| 6 | Current Price (End) | $60 (for example) |
| 7 | Option Profit | =MIN(B6-B2-B3,0)+B3 |
Explanation:
- Break-Even Price (B5): The price at which the investor would start making a profit is the sum of the current stock price and the premium paid.
- Current Price (B6): Assuming the stock price at the end of the period is $60.
- Option Profit (B7): The profit from the call option is calculated as the minimum of either the difference between the current price and the strike price or zero, plus the premium paid.
Result:
If the stock price at the expiration date is $60, the investor’s profit would be $8 per share ($60 – $55 – $3).
Other Approaches:
- Sensitivity Analysis: Use Excel’s data tables to conduct sensitivity analysis by changing variables like the stock price, strike price, and expiration date to understand the impact on option profitability.
- Graphical Representation: Create a payoff diagram in Excel to visually represent the potential profit or loss at different stock prices and visualize the breakeven point.
- Implied Volatility Analysis: Consider the impact of changes in implied volatility on option pricing using Excel functions like the Black-Scholes model.
