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Derivatives are an integral part of the global financial markets. Traders have the opportunity to speculate the price of an underlying asset without the requirement of owning the assets outright.
This gives a lot of flexibility to market participants and allows the market to be more efficient.
Options are some of the most popular types of derivatives and their underlying assets can range from anything to singular stocks and ETFs, to more complex assets, such as other derivatives and diversified funds.
When the market is rising and traders are optimistic about the future, they tend to buy call options, which give them the right, but not the obligation, to buy a specific underlying asset at a predetermined price, within a specified period, or on a specific date.
Call and put options are complex financial instruments and beginner traders are generally not advised to jump head first into the world of options trading, but it is nonetheless important to know the basic terms and how call options work in order to use them effectively in the future.
A call option gives a trader the right, but not the obligation, to buy an underlying asset at a predetermined strike price until the call option expires.
To better illustrate the concept, we can break down the components of a call option into the following:
Buying and selling call options gives holders certain rights and privileges that the holders of the underlying asset may not have.
The rights of an option holder include:
Options are attractive derivatives due to their limited risk and increased potential for profit. The profitability and risk mitigation of call options can be broken down as follows:
Writing call options comes with a few requirements and writing naked, or unsecured options, can be exceedingly risky and is generally not advisable:
To summarize the inherent advantages and disadvantages of call options and using these instruments for trading, we can highlight three crucial points for each side. This can help you weigh up your options and decide whether call options are the best choice for you at any given moment.
Call options give the holder the right, but not the obligation, to buy an underlying asset at a predetermined price (strike price) before or on a specified date (expiration). Traders buy calls to profit from rising asset prices or hedge against short positions.
When buying options, your maximum loss is limited to the premium paid. When writing (selling) options, potential losses can be significant, even unlimited, if the market moves against your position.
Yes, call options have expiration dates. They are contracts with a limited lifespan, after which they become worthless if not exercised. Traders can choose to exercise them and buy the underlying asset, or sell the option.