Explain how the possible profit and loss possibilities arise for an individual who invests in a:
Call options are financial derivative instrument which gives the buyer of the contract the right but not the obligation to buy the underlying asset. Underlying asset could be a stock, bond or commodity. The buyer of a call option profits when the price of the underlying asset increases.
Some of the terms used are
Strike price= price at which the option holder can exercise its option to buy
Spot price = current price of the asset
Premium=Amount paid for buying the option
Payoff of a call option:
Payoff of an option is the profitability under different price conditions. The buyer of the call option is always bullish and expects the price of the asset will go up. As the price increases, the payoff for the buyer increases.
Suppose, the trader is bullish on a stock trading at $30 (spot price S0). He believes the price will move above $33.10 in the next 30 days and buys the option at a strike price (SK) of $32.50. This option is trading at an option premium of $0.60. Suppose, he buys one contract of 100 shares, total cost for the trader would be ($0.60*100) = $60. If the price moves above $33.10, the trader will profit with the increase in the price. Suppose the price moves to $35. The profit for the trader would be as follows:
For 100 shares he will earn $1.90*100 = $190
However, if the price decreases, the loss wi...
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