3.1 – Buying call option
In the previous videos, we understood the broad context under which it makes sense to buy a call option. This chapter will formally structure our thoughts on the call option and get a firm understanding of both buying and selling of the call option.
We recommend reading this chapter on Varsity to learn more and understand the concepts in-depth.
Key takeaways from this chapter
- It makes sense to be a buyer of a call option when you expect the underlying price to increase.
- If the underlying price remains flat or goes down, then the call option buyer loses money.
- The money the buyer of the call option would lose is equivalent to the premium (agreement fees) the buyer pays to the seller/writer of the call option.
- The intrinsic value (IV) of a call option is a non-negative number
- IV = Max[0, (spot price – strike price)]
- The maximum loss the buyer of a call option experiences is to the extent of the premium paid. The loss is experienced as long as the spot price is below the strike price.
- The call option buyer has the potential to make unlimited profits, provided the spot price moves higher than the strike price.
- Though the call option is supposed to make a profit when the spot price moves above the strike price, the call option buyer first needs to recover the premium he has paid.
- The point at which the call option buyer completely recovers the premium he has paid is called the breakeven point.
- The call option buyer truly starts making a profit only beyond the breakeven point (which naturally is above the strike price)