Name of the Teacher: Gayathri Ravikumar

Department: Commerce PG.

Subject/Paper Financial Derivatives-5

Class M.com
Year II/SEM IV
Date 15/04/2020
Class Time 10:00-11:00am
Unit III
Topic Call Option Markets

Call Option

Lesson:2

A call option gives the holder the right to buy an underlying asset by a certain price. The
seller is under an obligation to fulfill the contact and is paid a price of this, which is called
“the call premium or call option price”

The price at which the underlying asset would be bought in the future at a particular date is
the strike price or Exercise Price .
The date on the options contract is called Expiration date.(the date when the contract
ends ).

There are two types of option based on the date.

1. European Option.
2. American Option

European option: Which can be exercised only on the maturity date.( the share can be sold
only on the maturity date and not before that )

American Option : Which can be exercised on the maturity date or before the maturity.
( The share can be sold even before the maturity date)

Payoff: The profit or loss the investor make by excising the call opyion.( by using call
option)

Calculation of payoff : (Stock price-Strike Price)

Calculation of profit : {(Stock Price –Strick prce)-Premium } that is
Payoff- Premium.

Example Problem on Call option.(European option )

Illustration 1

An Investor buys one European Call Option Of reliance Petroleum at a premium of Rs 2

per share on 31 july. The strike Price is Rs.60 and the contract matures on 30th September.
Explain weather the investor will exercise the option or not using pay of table .

Solution:

Strike price(Xt) =60

(initial investment )Premium(c) =2
Stock price(S) = Rs.58,Rs.60,Rs.62,Rs.64.

Stock price Strike price Premium Payoff Net Profit.

S Xt C (S-Xt) (S-Xt)-C
58 60 2 0(S-Xt) -2

60 60 2 0 -2

62 60 2 2 0

64 60 2 4 2

Payoff=(Stock Price-StrikePrice)
Net Profit= Payyoff-Premium(initial investment)

 If the stock price on 30th September is Rs.58 and the investor Strike price is
Rs.60,premium @ Rs.2. the investor will be at a loss of Rs. -2.
 The investor has to buy the share when the market price is Rs.64 in order to make a
profit of Rs .2.
Illustration 2:
An Investor buys a European call option to purchase 100 TATA share with a strike price of
Rs.320 per share on 1st April 2020 and the premium is 20 per share. .The current price of
TATA share is Rs. 310 per share. The expiration date of option is 2 months. Assume that
the share price is as following on the expiry date.
 If the price is Rs.300
 If the share price is Rs.320
 If the price is Rs.350

Solution:

a) If the Share price is 300, which is less than the market price the investor will not
make any profit .
Share price =300 per share
Strike Price=320 per share
Premium =20 per share (20X100=2000)
Initial investment =2000(Rs.20 per share X 100 share purchased)
The investor will be at a loss of Rs.2000(initial investment) because the market price is
less.

b) If the share price is 320,which is equal to market price.

Share price =300 per share

Strike Price=320 per share
Premium =20 per share (20X100=2000)
Initial investment =2000(Rs.20 per share X 100 share purchased)

The investor will be at a loss of Rs.2000(initial investment) because the market price is
less.

c) If the market Price is Rs.350, which is more than strike price.

Share price =350 per share

Strike Price=320 per share
Premium =20 per share (20X100=2000)
Initial investment =2000(Rs.20 per share X 100 share purchased)

{( Rs.350-Rs.320)x 100}=Rs.30 X 100 shares =Rs.3000

Payoff = 3000

Net Profit= Rs.3000-Rs.2000(premium)=1000

If the investor exercise the call option and purchases the share at Rs.320 which has the
current market price of Rs.350 , the investor will make a profit of
Rs 1000.

The above problem can be easily understood using Pay-Off Table (Per share)

Stock price Strike price Premium Payoff Net Profit.

S Xt C (S-Xt) (S-Xt)-C
300 320 20 0 -20

320 320 20 0 -20

350 320 20 30 10