Call on a Call
What Is a Call on a Call?
A call on a call (CoC, or CaCall) is a type of exotic option that gives the holder the right to buy a call option on the equivalent underlying. Basically, a call on a call option is an option to buy an option. It will have two strike prices and two expiration dates. One is for the compound call option, and the other is for the underlying vanilla option.
The call on a call is one of four types of compound options, otherwise called split-charge options or options on options. The others are: call on a put (CaPut); put on a put; and put on a call.
How a Call on a Call Works
Call on a call options are a type of exotic option with modified terms that trade on alternative exchanges. With a call on a call option, the holder has a secondary call option which gives them the right yet not the obligation to buy a plain vanilla call option with determined terms at a predefined price.
A call on a call can be beneficial to an investor on the off chance that it is offered at an optimal price. The holder of the secondary call has the right however not the obligation to buy a plain vanilla call. Generally, call on a call options are structured with American exercise. Hence, the investor has until the expiration date to exercise the secondary call. The secondary call and plain vanilla call can be exercised at the same time or separately.
In the event that the investor exercises the compound call at the same time, they accept the plain vanilla call is in the money and at its most beneficial pinnacle. At the point when both compound options are exercised, the investor receives the underlying call option which is then promptly exercised for receipt of the underlying security. Assuming the compound option holder decides to just execute the principal leg of the contract, then, at that point, they will receive the plain vanilla call option at its predetermined expiration and exercise price for future order.
At times, a call on a call option can be utilized by an investor to stretch out their exposure to an underlying asset for a minimal price. Numerous options allow a roll feature that accommodates extended exposure, however a call on a call option might allow this at a lower cost. For instance, in the event that the compound call holder tracks down the price of the underlying call option to be beneficial to their investment plans, they might exercise the main leg of the option to get the plain vanilla option with a future expiration date.
Pricing a Call on a Call
Before expiration, the value of the plain vanilla option will rely upon the value of the asset the underlying option addresses. In the options market, investors might utilize several methodologies to compute the value of their option. The Merton model is one method that has been presented for compound options.
A compound call on a call option is a complex option that conveys higher costs (premiums) than vanilla options. The investor will likewise be required to pay a transaction cost that factors in the execution of the two options. The cost of the compound option is important to consider as it can diminish the profitability of the investment overall.
Other Compound Options
The other three types of compound options are:
- Call on a put: This is a call option on an underlying put option. The owner who exercises the call option receives a put option.
- Call on a call: In this option, the investor buys one more call option with tweaked provisions. These provisions incorporate the right to buy a plain vanilla call option on an underlying security.
- Put on a call: The investor must deliver the underlying call option to the seller and collect a premium in view of the strike price of the overlying put option.
These options are otherwise called parted charge options.
Real World Application
While speculation in the financial markets will constantly be a major portion of compound option activity, business ventures could track down them valuable while planning or bidding on a large project. At times, they must secure financing or supplies before really starting or winning the project. On the off chance that they don't build or win the project, they could be left with financing they needn't bother with. In this case, compound options give an insurance policy.
The equivalent is likewise true for lenders, as they look to hedge their exposure would it be advisable for them they focus on giving the money required by businesses for their projects, and those businesses don't win their arrangements.
Features
- A call on a call option is an exotic option that gives the holder the right to purchase a plain vanilla option before the contract terminates.
- A call on a call option can be utilized by an investor to stretch out their exposure to an underlying asset for a minimal price and can be utilized in real estate development to secure property rights without being obliged to commit.
- A call on a call is in this way a type of compound option on an option including a call to buy a call.
