Call On A Call

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.