Call Option

Unlimited risk is particularly associated with:

  • selling (writing) an uncovered call option,
  • selling (writing) an uncovered call option,
  • forwards and futures transactions.

What are your rights and duties in an option transaction?

As the buyer of an option, you have the right to buy a specified amount of an underlying asset (often simply referred to as the “underlying”) from the seller (call option) or sell it to the seller (put option) at a predefined price (strike price) up until a set time (expiration date). The price you pay for this right is called the premium.

When are options settled physically, and when are they settled in cash?

Where a call option provides for physical settlement, you can require the seller of the option (writer) to deliver the underlying asset when you exercise the option. With a put option, the writer is obliged to buy the underlying asset from you.

What risks do you face as the buyer of an option?

Generally speaking, if the market value of the underlying asset falls, so does the value of your call option. The value of your put option tends to fall if the underlying asset rises in value. Normally, the less your option is in the money, the larger the fall in the option’s value. In such cases, value reduction normally accelerates close to the expiration date.

What is a covered option?

With a covered option, you purchase an underlying asset (equity, bond or currency) and simultaneously write a call option on that same asset. In return, you are paid a premium, which limits your loss in the event of a fall in the market value of the underlying asset. By the same token, however, your potential return from any increase in the asset’s market value is limited to gains up to the option’s strike price. Traditional covered options require that the underlying asset be lodged as collateral, which makes you the covered writer.

Lookback options

With a lookback option, the market value of the underlying is recorded periodically over a specified time period.

For a strike-lookback option the lowest value (call option) or the highest value (put option) of the underlying becomes the strike price.

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