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What is the difference between "right" and "obligation" on a call option?

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What is the difference between "right" and "obligation" on a call option?
posted Jul 6, 2017 by Anurag Kashyap

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1 Answer

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An option is a financial instrument whose value is derived from an underlying asset. A call option is an agreement that gives the buyer, or holder, the right to buy the underlying asset, or stock, at a predetermined strike price on or by a predetermined expiration date. The buyer of an option is not obligated to buy the stock at the strike price; he just has a right to do so if he chooses.

For example, an investor buys one XYZ call option with a strike price of $10, expiring next week for $1. If the stock trades at $10.05 the day after he buys it, he has the right to buy the stock for $10, but he is not forced to buy the stock.

On the other hand, a writer, or seller, of a call option is obligated to sell the underlying asset at a predetermined price, known as the strike price, if the call option the investor sold is exercised. The writer of a call option is paid to take on the risk that is associated with being obligated to deliver shares; the payment is known as the premium, or price of the option.

For example, an investor sells one TUV call option with a strike price of $15, expiring next week, for $1, and the stock is trading at $13. The writer collects a premium of $100 because an equity option contains 100 options per contract.

The investor is bearish on the stock and thinks the price of the stock will decrease. He hopes that the call will expire worthless.

The day before the option expires, company TUV publishes news that it's going to buy another company, and the stock price increases to $20. Many holders of the call options exercise their options to buy. The seller of the call option, then, is obligated to deliver 100 shares of TUV at $15.

answer Jul 6, 2017 by Pratiksha Shetty
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