A call option is an option to buy financial instruments at a specific price after a certain period. A call option is an option for the buyer to exercise not an obligation to perform. There can be an agreement between the buyer and seller for the purpose of the exchange of financial instruments; here buyer gets the right to buy stock/bond or other financial securities if buying is beneficial for him/her.
In a call option basically, a buyer makes an agreement with the seller if he thinks that there is a potentiality of positive change of instrument price in the market. So to get this opportunity a strike price is set for which securities will be exchanged and this contract is valid for a fixed period of time.
A question may arise that why sellers of stock/bonds or other financial securities want to make contact with the buyer although he knows that this contract will exercise only if the stock price is higher than the strike price. The main reason is that the seller assumes that the future price of this security will less than the strike price so that he will be the gainer.
For example Call Option
Suppose Mr. Jhon makes a contract with Mr. Sparrows to exercise a call option where they fixed a price (strike price) of an instrument is 80 Dollar i.e. Mr. Jhon will purchase this instrument only if the instrument price is higher than the strike price.
At the maturity of the contract the price of the stock is 100 Dollars, so Mr. Jhon will buy the stock at 80 dollars which will help him to make a profit of 20 dollars.
On the other hand, if this stock price is 79 dollars or less than this then this option will not be exercised.
The process of developing a call option:
- Buy a call option with the expectation of an increase in the market price
- If market-rate appreciates compared with a strike price
- Call option of yours will create value for you
- At the expiry date if the market price is higher than the strike price then you will exercise the call option which will generate profit for you.
Call options are an agreement (a written contract which is enforceable by law) between buyer and seller to buy and sell financial instruments with a fixed price determined earlier if the price of the instrument is higher than the market price then this contract will be exercised.