What is call option?
The main purpose of call options is to take advantage of the future price increase of a particular asset. Specifically, if an investor predicts that the price of a particular asset will rise, instead of purchasing that asset at today's price, he or she can purchase a call option to obtain the right to purchase it at a later date and at a specific price.
The main components of call options are:
1. **Call Price (Strike Price):** A specific price at which the owner of the call option has the right to purchase the asset by exercising the option. The value of the call option depends on the difference between this bid price and the current market price.
2. **Maturity Date:** The date on which the option expires. The owner of the call option can exercise the option only until the maturity date.
3. **Premium:** The fee paid by the buyer of the call option to purchase the option. This premium is the compensation that the buyer earns when paying the seller the right to purchase the asset at a certain price.
For example, if an investor thinks that a stock will increase in value in the future, he can buy a call option on that stock. This option provides the right to buy a stock at a certain price by a certain date. If the price of the stock is higher than the purchase price at the expiration of the option, the buyer can exercise the option to purchase the asset at a lower price and earn the difference as a profit. However, if the price of the stock remains below the purchase price, the buyer may not exercise the option and will only lose the premium paid.
1. **Limited Risk:** Owners of call options do not bear any risk other than the option premium. The premium they pay determines their maximum potential loss. This allows investors to limit their risk when speculating on the rise in the price of a particular asset.
2. **High Return Potential:** Call options offer high return potential to investors thanks to the leverage effect. When the asset price rises, investors who pay the option premium can make a profit at a low cost. However, this high return potential also comes with high risks.
3. **Hedging:** Call options can be used to hedge existing portfolios or positions. For example, if an investor owns a particular stock and is worried that its price may fall, he can limit potential losses by purchasing a call option on that stock.
4. **Taking Advantage of Price Volatility:** In a high volatility environment, call options can offer the opportunity to profit from rapid price changes. Unexpected movements in the markets can cause a rapid increase in the premiums of call options.
1. **Time Value Erosion:** The premiums of call options decrease rapidly as they approach expiration. This means that option holders lose some of their premium over time. Therefore, it is important to pay attention to timing and minimize losses as the option approaches expiration.
2. **Loss of Option Premium:** Option buyers lose the premium they paid if they do not exercise the option at the end of the maturity. Therefore, it is important to be careful and accurately predict the movement of the market when purchasing call options.
3. **Complexity of Exotic Options:** Complex derivative products, such as exotic call options, may carry more risk for investors. Before fully understanding the workings of such options, they need to be carefully researched and understood.
In addition to call options, there is also another type of option called a "put option." Put options are contracts that give the right to sell a specific asset at a certain price. Put options are used by investors who predict that the price of a particular asset will fall. Put option buyers have the right to sell the asset at a higher price if the price of the asset declines.
Put options offer advantages and disadvantages similar to call options:
Advantages:
1. **Risk Limitation:** Buyers of put options do not bear any risk other than the premium they pay. This allows investors to limit their potential losses if the price of their assets declines.
2. **Return Potential:** When the asset price falls, put option buyers can sell the asset at a price lower than the amount they paid in option premium. This offers the potential to make profits in falling markets.
3. **Hedging:** Put options offer investors the opportunity to hedge their assets against possible price declines.
Disadvantages:
1. **Time Value Erosion:** The premiums of put options also decrease over time. Therefore, there is a risk of losing some of the option premium if the market does not move in accordance with expectations.
2. **Loss of Option Premium:** Put option buyers lose the premium they paid if they do not exercise the option at the end of the maturity.
3. **Complexity of Exotic Options:** Some put options may involve complex derivative products, which carries more risk for investors.
As a result, put options offer the opportunity to hedge and make potential profits in falling markets, but they also involve certain risks. Investors should consider carefully to select option types that suit their risk tolerance and investment strategy.
4. **Dependency on Market Conditions:**
Call options gain or lose value depending on the direction and volatility of the market. If the market does not move as expected, the expected returns from call options may not be realized.
5. **High Spreads and Commissions:**
When buying and selling call options, high spreads and commissions are usually paid. This means that costs can increase when trading options and can reduce profits.
6. **Complexity and Risk Management:**
Call options can be complex financial instruments and difficult to understand correctly. If misunderstood or misapplied, investors can face huge losses. Therefore, it is important to develop proper risk management strategies when using call options.
7. **Limited Potential Return:**
Call options are acquired by paying a premium and the maximum potential return is limited to the price of the asset being above the purchase price at the expiration of the option. Therefore, call options offer limited return potential as the price of the asset rises.
Call options offer investors the opportunity to benefit from a rise in the price of a particular asset, but they also carry risks. Investors should conduct careful research to understand these risks and develop appropriate strategies and seek support from professional advisors when necessary.
