Like the Wall Street equivalent of a hat on a hat. There are call options (predicting the price of an asset will go up) and put options (predicting the price will go down) but there are also exotic options. (Sounds like something you might find on a South Seas Island.) A call on a call is a type of exotic option where an investor buys a secondary call option that gives him or her the right to buy a regular, "plain vanilla" call option at a particular price on a security.
The "underlying" asset of a plain vanilla call option could be a stock, a bond, a commodity or a foreign currency, while the underlying asset of a secondary option is always another option. The two calls can be traded at the same time or separately.
Why would an investor want to construct such a seemingly complicated deal? Sometimes they want to use a call on a call to extend the time they have to see where prices are headed on the underlying asset. He or she could exercise the secondary option in order to buy the plain vanilla one that has a later expiration date.
Using a call on a call can be a more expensive strategy (see Alligator Spread) as there will be two transaction costs for the execution of both the secondary and plain vanilla options. Also, it's a hugely volatile play...but when you're right, you can win huge...like 100x your money in a month kind of huge. Here's to having had good Karma in a past life.
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Finance: What Is a Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
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