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Buying Call Options

Buying a Call Option​

Buying a call option gives traders the right to purchase an asset at a specific strike price before the option expires. It is an effective strategy when you expect the asset’s price to rise but want to limit your risk to the premium paid for the option.

When to Buy a Call Option​

You should consider buying a call option when:

  1. You expect the underlying asset’s price to increase significantly.
  2. You want to limit your downside risk (maximum loss is the premium paid).
  3. You prefer to control a larger position without the need to invest the full capital required to buy the underlying asset.

Example​

Suppose Bajaj Auto is trading at ₹2,026, and you believe its price will rise over the next 15 days. Instead of purchasing the stock outright, you buy a 2050 call option by paying a premium of ₹6.35. There are three potential outcomes at expiry:

  • Scenario 1: If Bajaj Auto rises above ₹2,050 (e.g., ₹2,080), you can exercise the option and make a profit.
  • Scenario 2: If Bajaj Auto stays at or below ₹2,050, you can let the option expire, and your loss is limited to the premium paid.

Intrinsic Value and Break-even Point​

The intrinsic value of a call option is the difference between the spot price and the strike price, but it is always a non-negative value.
Example: If Bajaj Auto is trading at ₹2,068 at expiry, the intrinsic value of the 2050 call option is ₹18.

However, the break-even point accounts for the premium paid. In this case:
Break-even Point = ₹2,056.35 (strike price + premium).

You will only start making a profit once the stock price exceeds the break-even point.

Payoff Structure​

The payoff for a call option is unlimited on the upside, while the maximum loss is limited to the premium.

Here’s an example of the payoff for the 2050 Bajaj Auto call option:

Price MovementIntrinsic ValueProfit/Loss
₹2,0300-₹6.35 (premium loss)
₹2,060₹10₹3.65 (after premium)
₹2,080₹30₹23.65 (after premium)

Conclusion​

Buying a call option is a powerful tool for traders who anticipate upward price movement but wish to limit risk. AlgoTest users can apply this strategy using the Strategy Builder to test different call option setups and evaluate outcomes with the Simulator based on real historical data.