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POSTED BY ON October 16, 2012 1:40 am COMMENTS (5)
Can anyone please make me understand the meaning of ” Buyer of a call HAS RIGHT , but no OBLIGATION to exercise” whta does this mean has right but no obligation
And Seller of call has Obligation , but no right to refuse when exercise by buyer..(what does this line mean)
LAstly wht is the meaning of “he would square off”.
Thank you in advance in 1lot=100000thnxxxxx.
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Basically, when you Buy a Call (or a Put), you are the buying the RIGHT to Buy the underlying stock at the strike price (or the RIGHT to Sell the underlying stock at the strike price).
You dont actually have any obligation to buy or sell at the above price. You can just let the option expire, and your maximum loss is limited to the premium you paid.
From Seller’s point of view, he is selling you the right to Buy (or Sell), so obviously he has the obligation and not the right to Sell (or Buy) when the options are exercised. An Option seller can incur unlimited losses, unless an Option Buyer whose loss is limited to the premium paid.
Sriram
http://successfuloptionsstrategy.blogspot.in/
Thank you for your valuable response. I would like to know few more things,,,
There is TWO scenario , kindly tell among this two over the time say 5 years where will I get maximum return and following which route it will be a WEALTH BUILDER.
Scenario 1—Buying stocks in cash market worth Rs.10lakh and
Scenario 2—-Buying through F&O (in LOT) worth Rs.10 lakh. Here I mean to say both in Futures (LOT Rs.10lakh) and in Options (LOT Rs.10lakh). (But here what will happen after the EXPIRY to both future and option)
Basically F &O are for hedging i.e by taking a opposite position ONE can offset his loss.
Theory , says in CASH market the market value of investment almost will never be ZERO but it is not in the case of F&O . If it is so than how it can happen in F&O ,,, I have understood the BUY (CALL,PUT) part that the max loss is the premium . But I have not understood the SELL (CALL,PUT) part how can the person make UNLIMITED LOSS. Can’t the Person STOP his loss by closing his position here I understand that he has obligation is there no way OUT.
Let me give you an example
Lets talk about Reliance shares which is at Rs 1,000 per share . Now you bought 1 lot of Reliance CALL option, which has 100 shares in it . Lets say you bought Rs 1100 CALL at Rs 50 each . So you spend total 100 * 50 = Rs 5,000 .
Money which went out of your pocket = Rs 5,000 . Now what does that mean ?
This means that before the expiry date , which is the last thursday of each month, you can BUY 100 shares of Reliance at 1100 if you WISH . If you do not wish, you can choose to do nothing .
Now if the price of the share really goes up and lets say it goes upto Rs 1250 , in that case still you can CHOOSE to buy the shares at 1100 only, because you have those CALL options . Hence Its a RIGHT to buy , but not obligation, it totally depends on you ,if you want to buy or not . So in this case you can see , you can buy at 1100 and sell at 1250 , profit will be 150 each share, but as you had also bought the calls at 50 , so your net profit will be 100 per share , so for 100 shares , it will be 10,000 profit
Investment = 5000 , profit = 10,000
now what if the share prices went down to 600 ? In that case you do not have an obligation to buy the shares at 1000 , you can just not to do anything, and let have a loss of Rs 50 , which you paid for calls .
So loss = 5,000 . Your maximum loss here will be 5,000 only, but the profit potential is unlimited.
Because on the other side the SELLER of the call is there, he has the liability of SELL the Shares, If CALL owner says he wants to buy , then seller has no option , he has obligation to SELL .
Are you getting it now ?
Manish
Yes little bit getting but what is square off ?????
Does it mean selling all the stocks.
Options work this way:
Assume ICICI CMP is 1000
Call on 1050 (Strike Price) expiring in Oct 2012, let say has a premium of 30
What this means is:
The buyer is paying Rs. 30 premium to the seller. He now has the right to buy the ICICI Stock at 1050 before end of October Call expiry regardless of what the price of the stock is. He can choose to buy or not (that is the ‘right’).
If the ICICI stock goes to 1300 then the Call buyer has a massive gain. Since he has the ‘right’ to buy ICICI shares at 1050 he will definitely do so. In India usually people square off the call (If you buy a call then you need to sell to square off) instead of buying shares itself. In this case the Call Seller is ‘obligated’ to sell the shares to buyer at 1050.
If the ICICI stock goes to 900 then the Call buyer loss is limited to the premium paid. He still has the ‘right’ to buy the shares at 1050 but he can get it cheaper in the market and will let the call expire worthless.
Hope this clarifies.