The stock market is evolving drastically. With a few decades of high-tech changes and sophistication, high performance and highly advanced types of stock related transactions have come to be seen in the markets. The call option relating to stock is one such contract that has come into being quite recently and has gained quite a widespread popularity.
Stocks and Stock Options
For better understanding, let us do some stock options basics first. Stocks, or rather a common stock of a company is the total capital of a company, which is raised through investments from common people. The stock is divided into multiple shares, the price of one share being a low denominated. One person can hold multiple shares, and at the same time can also trade the shares in the stock markets.
A stock market works on the law of demand and supply. The premise of the price change is simple, more the demand of stock more is the price per share. On the contrary, lesser is the demand, lesser is the price per share. Thus depending upon the performance of a said company, its stock price dynamically changes.
For example, if a company acquires a giant contract, its stock price shoots up and if something bad happens, its price drops down. Stock investors and traders usually make their fortune by purchasing a said stock at lower prices and selling the same a giant price. These were some basics of stock market investing, now let's move on to the real definitions and explanations.
The stock option which has been introduced quiet recently, works on the very concept that the stock prices of a said company are dynamic and ever-changing. The stock option is basically a contract between a current stock/shareholder, and a potential investor, in accordance of which, a party (investor) has the right, but not the obligation to buy the said stock at a predetermined price. The act of drawing up the option is colloquially referred to as buying an option. Similarly a stock option, can also be used to give the seller a right to sell at a predetermined price.
Stock Call Option
As you must have noticed above, stock options are of two types, one, the option that gives the buyer a right to buy and two, the option that gives the seller an option to sell. The option that gives the right to a buyer, is known as a 'call' and the one that gives the seller the right to sell, is known as the 'put'. Here is how the call stock option works.
The call option on stocks, which is of course a contract, can be generated by paying the current stock holder a certain commission to contract. Then the terms and conditions of the option contract are decided.
The prominent conditions of the contract include,
- The first important element is the current details of the stock, that is the current market price and the number of shares that are subject to the option's contract.
- The next condition is a bit more important. This includes, the call time period, that is the time period (such as 2 months), within which the option can be exercised, that is the shares can be purchased.
- The third element is the price details. The share price is dynamic, which means that it is bound to change in the near future. Thus while generating the option, a price of shares is decided. This price is to be used to complete the transaction, irrespective of actual price of the shares at the time of transaction.
Now one very important thing that you need to know is that the investor, who is the buyer has a right to exercise call option, that is as per the price of the shares, he may or may not purchase the stock.
Consider this case. Two parties draw up a call option contract today, about the purchase of 500 shares, the market price per share being $100, as of today. The agreed or predetermined price of these shares is $120, and the call would extend up to 10 days, after one month from today, henceforth. Now there are two probabilities in such a case, one the price of shares may go to higher than $120, giving the buyer an excellent advantage, upon which he might execute the contract. Secondly, if the price goes down to $95, then there is no use of exercising the call option.
The contract is thus a tool to secure one's future investment at a relatively lower price. In some cases, this has proved to be so successful that some people have undertaken trading of options for a living. This often works to the advantage of both the parties. It must be noted that in cases where the call option is not exercised, the commission of the option contract is pocketed by the current holder of shares.