What is a Call Option in England?

A call option is a particular way in which investors can acquire shares in a business. This involves purchasing a special contract commonly referred to as a call option agreement. This contract gives the option holder the right (but not an obligation) to purchase shares in the company where they hold a call option. 

Understanding the different financial instruments and trading options available can help you manage your company’s share price. It may also be a valuable way to make speculative investments or hedge against risk. This article will explain some key features of a call option.

What is a Call Option?

Upon entering a call option agreement, the buyer or option holder receives the choice to buy shares in a company before a predetermined expiration date. They must exercise the option before the expiration date, otherwise, the contract will expire and the option holder will lose their right. 

The option holder will buy the option for the ‘strike price’, which is the value of the shares when the option holder enters into the contract. When a person buys an option contract, they also typically pay a premium. A premium is a fixed fee paid to obtain the value of the option in the first place.

A seller of an option contract may either be the company in question or a third party. When the buyer exercises their option, the seller must sell the shares at the strike price. 

As a business owner, you may want to enter into a share option with a buyer as a way to potentially generate cash if the buyer exercises their option. In this sense, call options are an alternative form of financing. But unlike traditional equity raises, there is no guarantee the option holder will exercise their options. It will only receive cash if the buyer exercises the option. 

Purpose of Call Options

The option holder benefits from the call option when the value of the shares at the time is greater than the strike price. By exercising the right under the option contract, the option holder effectively buys the price at a discount. 

For example, say the strike price is £50 per share and the market value of the share is £80 on the date you exercise your option rights. In exercising the right, you effectively acquire the shares for a 37.5% discount.  In some cases, you may have to pay the premium price at the point you exercise the option rather than when you enter into the contract. 

You are likely to encounter call options for public companies, but the same principles apply to private companies. 

Are Options Just Used by Investors?

Share options can be used speculatively by investors in the way described above. However, institutional investors may also use a call option as a hedging instrument. 

This is often done by investment banks, who will hedge against an investment by buying an option that goes against their position so as to limit the loss on the financial instrument that they have invested in if its value decreases. 

What Does a Call Option Agreement Include?

If you are considering entering into a call option agreement, you will want to familiarise yourself with its terms. A call option agreement will include a number of key provisions, such as:

• parties to the agreement;
• particular share that is being traded;
• option premium price;
• strike price of the underlying share;
• date on which the share option can be exercised;
• specific date on which the share option will expire;
• any conditions necessary to be able to exercise the option; and
• whether the option is exercised fully or partially.

A full exercise of an option is where you must purchase all of the underlying shares.  

Additionally, a partial exercise of an option is where you are entitled to purchase a portion of the total available shares under the contract. The contract may state a minimum number of shares you must opt to acquire. It may also permit you to exercise the options and acquire different portions at separate times. 

On the whole, options trading of shares in your company can influence its share price. At the same time, your business may want to make speculative investments in its own capacity, or hedge against potential risk. As such, it is worth knowing about how options work as a business owner. 

Key Takeaways

A call option is where an option holder obtains the right to choose whether to buy shares in a company for a fixed price in the future. The fixed price is determined at the point the buyer enters into the call option. The option holder can typically exercise their right at any point before the expiration date, and will also have to pay an option premium to the option seller. Understanding options can help your business make speculative investments, and it can also help your business hedge against risk. 

If you need help with your business, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.

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