call options
Over the last few weeks I have had a number of people connect with me and reach out to discuss their career and if I can help with next steps. Although it's quite flattering that people think my opinion is worthwhile (I will always respond and always be honest in my assessment), I thought it might be useful to give some basics of investment/portfolio management as useful content in the spirit of helping shed more light on our (investment community) terminology for aspiring investors.
I would like to begin with derivatives as a starter and particularly focus on a 'call option' which can be used in fund management in various ways.
Firstly, a call is a contract that gives the holder the right (but not the obligation) to buy a specific quantity of an instrument (i.e. stock) at a pre-determined price within a specific period of time. The key characteristics of a call are:
1. Asset i.e. Vodafone shares
2. Strike price i.e. 70p
3. Expiry Date i.e. July 2024
4. Premium - this is the price paid by the buyer to the seller (writer) of the option
If the share price of the underlying Vodafone stock rises above the strike price (70p) by the option expiry date (July 2024), the holder can 'exercise' the option to receive the stock at 70p and sell in the market at the higher price, thus locking in a profit. Alternatively, if the share price never rises above the strike price, the buyer would lose the premium paid and the option expires worthless. Therefore capital is at risk using these strategies.
There are 3 primary reasons why you would use call options for portfolio management:
1. Leverage - paying the premium gives you an exposure to an asset (Vodafone stock in our example) but without the direct ownership of the stock for a small price, thus allowing potentially leveraged returns.
2. Income generation - writing (selling calls) on stocks you already own is called 'covered call writing' which allows you to take the income from the premium and would still allow you to sell the stock at a higher price.
3. Hedging - call options can be used to ensure investors don't miss out on potential upside to a holding if they are already short the position (shorting is for another day).
Options can be complex and therefore care should be taken when thinking about deploying these strategies and seeking expert advice is helpful.
Demystifying some of the terminology is one way of helping investors get comfortable with options strategies.
I hope this is helpful and please continue to reach out if you think I can be helpful. I'm pretty sure Greg Sinnott or Bruce Williams will pick up any inaccuracies!
