Call Options Basics: How it Works in Practice?

Call options are an essential part of options trading, offering investors the right—but not the obligation—to buy an asset at a predetermined price. Understanding how call options work can help traders and investors leverage their positions, hedge risks, and maximise profits.

What Is a Call Option?

A call option is a financial contract that gives the holder the right (but not the obligation) to buy a specific quantity of an underlying asset at a predetermined price (strike price) before a set expiration date. If the option is not exercised before expiry, it becomes worthless.

Call options allow investors to benefit from rising asset prices without actually owning the asset. If the market price exceeds the strike price before the expiration date, the call option holder can exercise the contract, purchasing the asset at a lower price and making a profit. However, if the price does not surpass the strike price, the option expires worthless, and the investor only loses the premium paid for the option.

In short, a call option gives you a right to buy without an obligation, meaning you can execute the contract only when it is profitable.

A Guide to Call Buying Strategy

Traders buy call options when they are bullish on an asset. This means they expect the asset’s price to rise. Buying call options is a way to leverage a position with a smaller capital investment.

Similarly Traders buy Put Options when they expect an asset’s price to decline, indicating a bearish outlook. This strategy enables them to profit from falling prices while requiring a smaller capital investment.

Let’s understand this with an example:

• Assume ABC Company’s stock is trading at ₹50 per share.

• You purchase 100 call option contracts with a strike price of ₹55 at a premium of ₹3 per contract.

• After one month, ABC’s stock price rises to ₹65.

Here’s how you calculate the profit:

• Market Price – Strike Price = ₹65 – ₹55 = ₹10 (Notional gain per share)

• Total Notional Gain = ₹10 × 100 = ₹1,000

• Premium Paid = ₹3 × 100 = ₹300

• Net Profit = ₹1,000 – ₹300 = ₹700

Since call options allow investors to participate in price increases with limited downside risk, they are a popular choice for traders.

What Is Leverage in Call Options?

Leverage is one of the biggest advantages of options trading. Instead of buying the stock outright, you can control the same number of shares with a much smaller investment.

Using the above example, if you were to buy 100 shares of ABC at ₹50, you would need ₹5,000. But with call options, you only spend ₹300 (₹3 × 100).

• If the stock price rises, your profit potential is the same, but your initial investment is significantly lower.

• If the stock price falls, your maximum loss is limited to ₹300, whereas if you bought shares outright, you could lose much more.

This is why call options are considered a low-risk way to gain exposure to rising markets.

ITM, ATM, and OTM Call Options

Call options are classified into three categories based on their relationship with the market price:

• In-the-Money (ITM): The market price is higher than the strike price.

• At-the-Money (ATM): The market price is equal to the strike price.

• Out-of-the-Money (OTM): The market price is lower than the strike price.

For example, if Infosys stock is trading at ₹1,000:

• A ₹980 Call Option is ITM.

• A ₹1,000 Call Option is ATM.

• A ₹1,020 Call Option is OTM.

Understanding these categories helps traders decide which options to buy based on their risk appetite.

Factors Influencing Call Option Prices

The price of a call option (premium) is affected by several factors:

1. Intrinsic Value

• This is the difference between the market price and the strike price.

• ITM options have positive intrinsic value, while OTM options have zero intrinsic value.

2. Time to Expiration

• The longer the time to expiration, the higher the option premium.

• As expiry approaches, the time value declines (this is known as time decay).

3. Implied Volatility

• Higher volatility increases an option’s premium since it raises the chance of profitable price movement.

4. Interest Rates

• Higher interest rates can reduce call option premiums, as holding cash becomes more attractive compared to options trading.

5. Greek Values

• Delta, Gamma, Theta, and Rho are important metrics that measure how an option’s price reacts to various market conditions.

Understanding Time Value in Call Options

A call option’s premium consists of two parts:

Premium =  Intrinsic Value + Time Value

• ITM options have both intrinsic value and time value.

• OTM options only have time value.

For example, if Infosys stock is trading at ₹1,000:

This table shows how ITM options carry intrinsic value, while OTM options are entirely based on time value.

Options Trading in India

1. Cash Settlement of Options

In India, options are cash-settled—this means profits and losses are adjusted in cash instead of delivering shares.

2. Index vs. Stock Call Options

• Index call options (e.g.,Nifty, Bank Nifty) depend on index movement.

• Stock call options (e.g., Reliance, Infosys) are tied to individual stock prices.

3. Monthly & Weekly Expiry

• Stock options have monthly expiry (last Thursday of the month).

• Index options may have weekly expiry (e.g., Sensex and Nifty).

4. European vs. American Call Options

• European call options can be exercised only at expiry.

• American call options can be exercised at any time before expiry.

• In India, all options are European-style.

Key Takeaways

• A call option grants the right to buy an asset at a predetermined price.

• It is profitable when the market price exceeds the strike price at expiry.

• The option premium is influenced by factors like intrinsic value, time value, and volatility.

• Options trading in India is cash-settled and follows European-style execution.

FAQs

1. What Is a Long Call Option?

A long call is a strategy where a trader buys a call option, expecting the asset price to rise.

2. What Is a Short Call Option?

A short call is a strategy where a trader sells a call option, expecting the asset price to remain the same or decline.

3. When Should You Buy a Call Option?

When you anticipate a significant price increase in the underlying asset.

4. When Should You Sell a Call Option?

When you expect the price to remain stable or decrease, and want to collect the premium as profit.

Disclaimer: The information provided in this article is for informational and educational purposes only and should not be considered financial, investment, or professional advice. While we strive for accuracy, we do not guarantee the completeness or reliability of the content. Always conduct your own research or consult a qualified financial advisor before making any investment decisions. MarketUnder.com and its authors are not responsible for any financial losses or decisions made based on this information.