Call option
1.
An option which gives the holder the right to buy a specified quantity of a physical underlying asset, such as a commodity, at the strike price specified by the option.
The holder will only exercise the option if it is beneficial for the holder to do so, based on the difference between the strike price and the price of the underlying asset at the maturity of the option.
Example: Choices
- CALL options protect buyers, or users, of assets against RISES in the market price of the asset.
- Say we will need 1m tonnes of an asset for our production process.
- We could buy a call option to buy 1m tonnes at $60 per tonne.
- The call option protects us against the market price rising higher than $60.
- It gives us the right to BUY 1m tonnes for $60 - IF WE CHOOSE TO DO SO.
- If the market price is HIGHER than $60, we will EXERCISE our call option, and pay $60m in exchange for the asset we need, under the option.
- If the market price is lower, we’ll allow the option to lapse, and buy the asset we need in the market for the cheaper current market price.
- Hedging our position with the option establishes a MAXIMUM “cap” level for our commodity input expense.
- In exchange for paying the up front call option premium.
2.
A similar option over a non-physical underlying asset.
Cash settlement
In practice many options are cash-settled by a payment, if relevant, by the writer (or seller) of the option to the holder, at the maturity date of the option.
There will be a payment if the underlying asset price is favourable for the option holder, compared with the strike price of the option.
Options over non-physical underlying assets are always cash-settled.
Foreign exchange call options
A foreign currency call option is the option to buy a specified quantity of the base currency in the currency pair, at the strike rate specified in the option.
Interest rate options
Borrowers' options hedge against a rise in interest rates.
For options over forward rate agreements, this is a call option.
Call options over short-term interest rate futures contracts are lenders' options.
These hedge against a fall in interest rates.
