Call Option

Background

A call option is a type of financial derivative that provides the holder the flexibility to purchase a set number of units of an underlying asset at a pre-determined price (the strike price) on or before a specific date (the exercise date). This derivative instrument enhances the ability of the holder to capitalize on favorable price movements without the obligation to complete the purchase if conditions are not beneficial.

Historical Context

Financial derivatives have a long history, dating back to ancient times. However, the sophisticated options market we recognize today, including call options, developed significantly in the 20th century. The advent of the Chicago Board Options Exchange (CBOE) in 1973 helped standardize and institutionalize options trading. The introduction of the Black–Scholes equation in the same year revolutionized the valuation process and provided a theoretical framework for option pricing.

Definitions and Concepts

A call option grants the buyer the right, but not the commitment, to purchase an asset at a pre-agreed price on or before a set date. Here’s a breakdown:

Strike Price: Pre-arranged price at which the asset can be bought.
Exercise Date: Specific date when the option can be utilized.
Spot Price: The current market price of the asset.

Types of Call Options:

American Call Option: Can be exercised at any time before the expiry date.
European Call Option: Can only be exercised on the expiry date itself.

Major Analytical Frameworks

Classical Economics

Classical economics does not specifically deal with financial derivatives like call options as it predates their prominence.

Neoclassical Economics

Neoclassical economics involves utility maximization and value determination under the Efficient Market Hypothesis, influencing modern day investment behaviors including those regarding call options.

Keynesian Economics

Keynesian theory might address market sentiment and expectations as potential influences on option pricing and trading behavior.

Marxian Economics

Marxian economics critiques the speculative nature of financial markets but does not typically engage with the specific mechanics of instruments like call options.

Institutional Economics

Consideration of how market institutions regulate and influence option trading behavior might be prevalent in institutional economics.

Behavioral Economics

Behavioral economics examines how psychological factors and cognitive biases affect trading behaviors and option pricing.

Post-Keynesian Economics

This branch addresses market imperfections and investor confidence, which may influence strategic decisions involving call options.

Austrian Economics

Focus on deduced human actions and time preference may marginally touch on speculative instruments like call options.

Development Economics

It’s less likely to directly address call options but may involve discussions on market accessibility and speculative trading within developing economies.

Monetarism

Monetarism may delve into how the money supply affects financial markets and indirectly impacts the valuation and trading of call options.

Comparative Analysis

Call options are often compared with put options, which provide the right to sell instead of buy. Both have unique risk profiles and hedging capabilities that form complementary strategies in options trading.

Case Studies

Consider reviewing major market events including the Dot-com bubble or the 2008 financial collapse to understand how option pricing and trading are impacted under various economic conditions.

Suggested Books for Further Studies

“Options, Futures, and Other Derivatives” by John Hull
“Option Volatility and Pricing” by Sheldon Natenberg
“The Black-Scholes Model” by Maciej Zwara

Put Option: A derivative allowing the holder to sell a fixed number of units of an asset at a pre-determined price on or before a future date.
Strike Price: The fixed price at which the holder of an option can buy/sell the underlying asset.
Black–Scholes Model: A mathematical model for pricing options and corporate liabilities.
Derivative: A financial security whose value is dependent upon or derived from an underlying asset or group of assets.