WikiMili The Free Encyclopedia

This article needs additional citations for verification .(October 2011) (Learn how and when to remove this template message) |

A **call option**, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option.^{ [1] } The buyer of the call option has the right, but not the obligation, to buy an agreed quantity of a particular commodity or financial instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument to the buyer if the buyer so decides. The buyer pays a fee (called a premium) for this right. The term "call" comes from the fact that the owner has the right to "call the stock away" from the seller.

In finance, an **option** is a contract which gives the buyer the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price prior to or on a specified date, depending on the form of the option. The strike price may be set by reference to the spot price of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount or at a premium. The seller has the corresponding obligation to fulfill the transaction – to sell or buy – if the buyer (owner) "exercises" the option. An option that conveys to the owner the right to buy at a specific price is referred to as a call; an option that conveys the right of the owner to sell at a specific price is referred to as a put. Both are commonly traded, but the call option is more frequently discussed.

In economics, a **commodity** is an economic good or service that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them.

**Financial instruments** are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity (share), or a contractual right to receive or deliver cash (bond).

Option values vary with the value of the underlying instrument over time. The price of the call contract must act as a proxy response for the valuation of the (1) estimated time value — thought of as the likelihood of the call finishing in-the-money and (2) the intrinsic value of the option, defined as the difference between the strike price and the market value multiplied by 100. The call contract price generally will be higher when the contract has more time to expire (except in cases when a significant dividend is present) and when the underlying financial instrument shows more volatility. Determining this value is one of the central functions of financial mathematics. The most common method used is the Black–Scholes formula. Importantly, the Black-Scholes formula provides an estimate of the price of European-style options.^{ [2] }

A **dividend** is a payment made by a corporation to its shareholders, usually as a distribution of profits. When a corporation earns a profit or surplus, the corporation is able to re-invest the profit in the business and pay a proportion of the profit as a dividend to shareholders. Distribution to shareholders may be in cash or, if the corporation has a dividend reinvestment plan, the amount can be paid by the issue of further shares or share repurchase. When dividends are paid, shareholders typically must pay income taxes, and the corporation does not receive a corporate income tax deduction for the dividend payments.

In finance, **volatility** is the degree of variation of a trading price series over time as measured by the standard deviation of logarithmic returns.

Whatever the formula used, the buyer and seller must agree on the initial value (the premium or price of the call contract), otherwise the exchange (buy/sell) of the call will not take place.

Adjustment to Call Option: When a call option is in-the-money i.e. when the buyer is making profit, he has many options. Some of them are as follows:

- He can sell the call and book his profit.
- If he still feels that there is scope of making more money he can continue to hold the position.
- If he is interested in holding the position but at the same time would like to have some protection, he can buy a protective "put" of the strike that suits him.
- He can sell a call of higher strike price and convert the position into "call spread" and thus limiting his loss if the market reverses.

Similarly if the buyer is making loss on his position i.e. the call is out-of-the-money, he can make several adjustments to limit his loss or even make some profit.

Trading options involves a constant monitoring of the option value, which is affected by the following factors:

- Changes in the
**base asset price**(the higher the price, the more expensive the call option is) - Changes in the
**volatility**of the base asset (the higher the volatility, the more expensive the call option is) **Time decay**– as time goes by, options become cheaper and cheaper.

Moreover, the dependence of the option value to price, volatility and time is **not linear** – which makes the analysis even more complex.

One very useful way to analyze and track the value of an option position is by drawing a **Profit / Loss chart** that shows how the option value changes with changes in the base asset price and other factors. For example, this Profit / Loss chart shows the profit / loss of a call option position (with $100 strike and maturity of 30 days) purchased at a price of $3,5 (blue graph – the day of the purchase of the option; orange graph – at expiry):

- Put option
- Binary option
- Bond option
- Credit default option
- Exotic option
- Foreign exchange option
- Interest rate cap and floor
- Options on futures
- Stock option
- Swaption

In finance, a **put** or **put option** is a stock market device which gives the owner the right, but not the obligation, to sell an asset, at a specified price, by a predetermined date to a given party. The purchase of a put option is interpreted as a negative sentiment about the future value of the underlying stock. The term "put" comes from the fact that the owner has the right to "put up for sale" the stock or index.

A **binary option** is a financial exotic option in which the payoff is either some fixed monetary amount or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option. The former pays some fixed amount of cash if the option expires in-the-money while the latter pays the value of the underlying security. They are also called **all-or-nothing options**, **digital options**, and **fixed return options** (**FROs**).

In finance, a **bond option** is an option to buy or sell a bond at a certain price on or before the option expiry date. These instruments are typically traded OTC.

- Covered call
- Moneyness
- Naked call
- Naked put
- Option time value
- Pre-emption right
- Put option
- Put–call parity
- Right of first refusal

A **covered call** is a financial market transaction in which the seller of call options owns the corresponding amount of the underlying instrument, such as shares of a stock or other securities. If a trader buys the underlying instrument at the same time the trader sells the call, the strategy is often called a "buy-write" strategy. In equilibrium, the strategy has the same payoffs as writing a put option.

In finance, **moneyness** is the relative position of the current price of an underlying asset with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a three-fold classification: if the derivative would have positive intrinsic value if it were to expire today, it is said to be **in the money**; if it would be worthless if expiring at the current price it is said to be **out of the money**, and if the current price and strike price are equal, it is said to be **at the money**. There are two slightly different definitions, according to whether one uses the current price (spot) or future price (forward), specified as "at the money spot" or "at the money forward", etc.

A **naked call** occurs when a speculator writes (sells) a call option on a security without ownership of that security. It is one of the riskiest options strategies because it carries unlimited risk as opposed to a naked put, where the maximum loss occurs if the stock falls to zero. A naked call is the opposite of a covered call.

The **Black–Scholes** or **Black–Scholes–Merton model** is a mathematical model for the dynamics of a financial market containing derivative investment instruments. From the partial differential equation in the model, known as the Black–Scholes equation, one can deduce the **Black–Scholes formula**, which gives a theoretical estimate of the price of European-style options and shows that the option has a *unique* price regardless of the risk of the security and its expected return. The formula led to a boom in options trading and provided mathematical legitimacy to the activities of the Chicago Board Options Exchange and other options markets around the world. It is widely used, although often with adjustments and corrections, by options market participants.

In finance, the **style ** or **family** of an option is the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either **European** or **American** (style) options. These options—as well as others where the payoff is calculated similarly—are referred to as "vanilla options". Options where the payoff is calculated differently are categorized as **"exotic options"**. Exotic options can pose challenging problems in valuation and hedging.

In finance, a **futures contract** is a standardized forward contract, a legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usually a commodity or financial instrument. The predetermined price the parties agree to buy and sell the asset for is known as the *forward price*. The specified time in the future—which is when delivery and payment occur—is known as the *delivery date*. Because it is a function of an underlying asset, a futures contract is a derivative product.

In mathematical finance, the **Greeks** are the quantities representing the sensitivity of the price of derivatives such as options to a change in underlying parameters on which the value of an instrument or portfolio of financial instruments is dependent. The name is used because the most common of these sensitivities are denoted by Greek letters. Collectively these have also been called the **risk sensitivities**, **risk measures** or **hedge parameters**.

In financial mathematics, the **implied volatility** (**IV**) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model will return a theoretical value equal to the current market price of the option. A non-option financial instrument that has embedded optionality, such as an interest rate cap, can also have an implied volatility. Implied volatility, a forward-looking and subjective measure, differs from historical volatility because the latter is calculated from known past returns of a security. To understand where Implied Volatility stands in terms of the underlying, **implied volatility rank** is used to understand its implied volatility from a one year high and low IV.

A **hedge** is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles, many types of over-the-counter and derivative products, and futures contracts.

In finance, the **time value** (**TV**) of an option is the premium a rational investor would pay over its *current* exercise value, based on the probability it will increase in value before expiry. For an American option this value is always greater than zero in a fair market, thus an option is *always* worth more than its current exercise value.. As an option can be thought of as 'price insurance', TV can be thought of as the *risk premium* the option seller charges the buyer—the higher the expected risk, the higher the premium. Conversely, TV can be thought of as the price an investor is willing to pay for potential upside.

**Rational pricing** is the assumption in financial economics that asset prices will reflect the arbitrage-free price of the asset as any deviation from this price will be "arbitraged away". This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to the pricing of derivative instruments.

In finance, a **foreign exchange option** is a derivative financial instrument that gives the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. See Foreign exchange derivative.

In finance, a **long** position in a financial instrument means the holder of the position owns a positive amount of the instrument. The holder of the position has the expectation that the financial instrument will increase in value. This is known as a bullish position. It is contrasted with *going short*, also called a bearish position.

**Volatility smiles** are implied volatility patterns that arise in pricing financial options. It corresponds to finding one single parameter that is needed to be modified for the Black–Scholes formula to fit market prices. In particular for a given expiration, options whose strike price differs substantially from the underlying asset's price command higher prices than what is suggested by standard option pricing models. These options are said to be either deep in-the-money or out-of-the-money.

In finance, a price (premium) is paid or received for purchasing or selling options. This article discusses the calculation of this premium in general. But for further detail, see Mathematical finance #Derivatives pricing: the Q world for discussion of the mathematics, and Financial modeling #Quantitative finance for the implementation.

The **iron condor** is an option trading strategy utilizing two vertical spreads – a put spread and a call spread with the same expiration and four different strikes. A long iron condor is essentially selling both sides of the underlying instrument by simultaneously shorting the same number of calls and puts, then covering each position with the purchase of further out of the money call(s) and put(s) respectively. The converse produces a short iron condor.

**Option strategies** are the simultaneous, and often mixed, buying or selling of one or more options that differ in one or more of the options' variables. Call options, simply known as calls, give the buyer a right to buy a particular stock at that option's strike price. Conversely, put options, simply known as puts, give the buyer the right to sell a particular stock at the option's strike price. This is often done to gain exposure to a specific type of opportunity or risk while eliminating other risks as part of a trading strategy. A very straightforward strategy might simply be the buying or selling of a single option, however option strategies often refer to a combination of simultaneous buying and or selling of options.

The **backspread** is the converse strategy to the ratio spread and is also known as reverse ratio spread. Using calls, a bullish strategy known as the call backspread can be constructed and with puts, a strategy known as the put backspread can be constructed.

**Financial betting** refers to the wagering on the price development of a financial instrument at some later date relative to the current price or level of the instrument, against odds offered by a bookmaker. Maximum potential pay-off of the wager is known when the bet is taken and as a corollary risk is known beforehand by being limited to the initial stake.

- ↑ O'Sullivan, Arthur; Sheffrin, Steven M. (2003).
*Economics: Principles in Action*. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 288. ISBN 0-13-063085-3. - ↑ Fernandes, Nuno (2014).
*Finance for Executives: A Practical Guide for Managers*. NPV Publishing. p. 313. ISBN 978-9899885400.

This page is based on this Wikipedia article

Text is available under the CC BY-SA 4.0 license; additional terms may apply.

Images, videos and audio are available under their respective licenses.

Text is available under the CC BY-SA 4.0 license; additional terms may apply.

Images, videos and audio are available under their respective licenses.