Saturday, 22 February 2014

When Call Options May be Used?

1.  Call options benefit buyers when the price of the underlying stock rises above the strike or exercise price. 
  • Investors buy calls when they are bullish on the stock.
  • If an investor bought the call option instead of the stock, the greatest percentage return would come from selling the option, due to the concept of leverage.  
  • If the market price of the stock declines below the strike price of the option, the most the investor would lose is the option premium.

2.  Call options may also be used as a hedge against an upturn in the price of a stock on a short position.  
  • Assume that an investor had sold short 100 shares of stock A when it was $80 per share.  
  • When the price of stock A declines to $69 per share, the investor wants to protect the $11 profit per share against a rise in the price of the stock A.  
  • The investor could buy a call option , which has a strike price of $70 per share.  
  • For every $1 increase in stock A above $70 per share, there is a profit on the call option that offsets the loss on the short sale..  
  • If, however, stock A continues to go down in price, the investor has lost only the amount paid to buy the option.  
  • This strategy allows an investor to protect profits without having to close out his position.

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