Buying Call Options
A call option gives the holder the right to buy an asset at a certain price (strike price) by a certain date (Expiration)
Payoff Diagram: Buying a call option
In this example we are using the following assumptions:
Sol Price: $100
Will thinks that the price of SOL is going to rise past $100. He wants a way of benefitting from the potential upside of SOL's price going up whilst minimising his potential downside if SOL's price goes down. Will might buy call options to accomplish this.
If Will pays $5 to buy the SOL May 30th $110 call option, he is buying the right to pay $110 (the strike price) for one SOL token on or before May 30th. The $5 he pays is called the premium. Let’s compare the outcomes of buying one of these calls for $5 to buying SOL for $100. Lets look at the scenarios that could occur on May 30th:
Scenario 1 (The price of SOL rises):
Assuming that SOL has risen to $150. If Will had spot bought one SOL for $100, he would make $50 on his investment (+50%). However, If he had bought the May 30th $110 call for $5, he can purchase the coin for $110 and sell it for $150, netting $35 profit ($150 - $110 - $5). This is a 700% profit return on his $5!!!!. Will makes a greater return than had he simply spot bought SOL.
Scenario 2 (The price of SOL stays the same):
Assuming that SOL stays at $100. If Will had bought one SOL for $100, he would neither have made or lost money. whereas, if he had bought the call for $5, he would lose $5. In this scenario, the option is worthless as the strike price is greater than the token price. In the case of the asset price not moving options can do poorly, Will lost his entire investment compared to being even had he spot bought the token.
Scenario 3 (The price of SOL falls):
Assuming that SOL falls to $50. If Will had spot bought one SOL for $100, he would lose $50 (-50%). If he had bought the call for $5, he would only lose $5. Will only lost $5 compared to losing $50 had he spot bought the token. Note that he still retained the upside potential in the case that SOL had increased in value.
Why trade it? You think the price of the asset is going up within a certain time frame.
What are the optimal conditions? Cheap volatility, bullish asset.
What is the cost: The premium you pay.
Max Profit: Unlimited.
Max Loss: The price you paid for the call.
Breakeven at expiration: The strike plus the price you paid for the call.