Uses of the Call Option Contract




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A man thinks that a stock, now selling in the market at 50, is going to have a substantial rise. He buys a Call option on 100 shares at 50, good for 90 days, for $350 plus tax. The federal and state tax departments demand that tax stamps be affixed to Call options (but not to Puts).

A Call option is a contract, paid for when it is purchased, which gives the holder the right to buy, at his option, a specified number of shares of a stated stock at a fixed price, on or before a fixed date.

The option money is the amount paid for the option contract. Should the option be exercised, it is not applied against the purchase price of the stock.

If you pay $500 for a Call on XYZ at 70 and you exercise the Call, you pay 70 for the stock, less any dividends or rights that belong to the contract.

The Use of a Call Contract for Speculation

A man thinks that a stock, now selling in the market at 50, is going to have a substantial rise. He buys a Call option on 100 shares at 50, good for 90 days, for $350 plus tax.

The federal and state tax departments demand that tax stamps be affixed to Call options (but not to Puts). This tax, paid for by the buyer of the option at the time he buys it, is the same amount that would be paid by a seller on a sale of the stock at the Call price.

The maximum is $12 per 100 shares and is fixed according to the dollar value of the stock involved. When the trader buys the Call option at 50, good for 90 days, for $350, this amount is the most he can lose, no matter what happens to the stock. If the trader is correct in his judgment and the stock rises to, let us say, 70, before his Call contract expires, he buys the stock by exercising his Call and sells the stock in the market at 70.

His profit is $2,000 less the cost of the Call contract, and his account shows:

Bought call 100 XYZ at 50 for $ 350
Bought 100 shares at 50 thru Call 5,000 $5,350
Sold 100 shares at 70 $7,000
Profit $1,650

The transaction shows a profit of almost 500 per cent of the $350 at risk.

In making such a trade, when the stock is Called and sold on the same day, the holder of the Call contract will be required to deposit margin of 25 percent of the sale price—70—with his stock-exchange broker until the trade clears on the fourth business day following the trade.

Please remember that not only does the cost of the option constitute the total risk to the holder, but the choice of exercising the option also belongs to the holder of the contract and he will exercise his option only if it is to his advantage to do so. The seller or maker of the contract has no choice—he must live up to the terms of the contract at the option of the holder of the contract.

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