What Is A Call Option?
A call option is a financial contract that grants the option buyer the right, but not the duty, to purchase a stock, bond, commodity, or other asset or instrument at a given price and within a specific period.
If the stock’s market price increases over the option’s strike price, the option holder can exercise their option by purchasing at the strike price and selling at the higher market price to lock in a profit. A call is a type of options contract that grants the owner the right, but not the duty, to purchase a specific amount of an underlying security at a set price within a given time frame. The predetermined price is known as the striking price, and the time during which a transaction is made is known as the expiry or time to maturity.
Call options are “in the money” when the stock price is above the strike price at expiration. The call owner can exercise the option, putting up cash to buy the stock at the strike price. Or the owner can sell the option at its fair market value to another buyer before it expires. If the stock price is below the strike price at expiration, then the call is “out of the money” and expires worthless. The call seller keeps any premium received for the option.
Call Option Example
For example, if a stock is trading at $50 per share, you would ideally sell a call option at $53 per share. However, because you are selling a call option, you are obligated to sell the shares at the low call price and buy back the shares at the market price (unlike when you buy a call option, which reserves the right not to buy the stock). Still, the max profits for this strategy are limited to the premium (which, since you’re selling a call, you get immediately). With this strategy, you need to be relatively bearish on the stock or underlying security because the underlying price must stay below the strike price. However, as a bonus, time decay is actually to this strategy’s benefit – since, with selling a short call option, you want the option to be worthless at its expiration date (since you’ll pocket the premium). So unlike other call options strategies, time decay generally works in your favor.« Back to Glossary Index