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What is a Call Option?
A call option is a financial contract that gives the buyer the right, but not the obligation, to purchase an underlying asset at a specified price within a defined period.
Definition
A call option is a derivatives contract that allows the holder to buy an underlying asset at a predetermined strike price before or on the expiration date.
Key Takeaways
- Gives holders the right to buy an asset at a set price.
- Buyers expect the asset’s price to rise.
- Sellers (writers) assume the obligation to deliver the asset if exercised.
- Used in hedging, speculation, and income strategies.
Understanding Call Options
Call options are widely used in financial markets to leverage upside potential while limiting downside risk. When an investor purchases a call option, they pay a premium for the right to buy the underlying asset—such as a stock, commodity, or index—at the strike price.
If the market price exceeds the strike price before expiration, the option becomes profitable (“in the money”). If not, the option expires worthless, and the buyer only loses the premium.
Option writers profit by collecting premiums but face potential losses if prices rise sharply.
Real-World Example
An investor buys a call option on Stock X with a strike price of $50 and a premium of $3. If Stock X rises to $60, the option’s intrinsic value becomes $10, delivering a profit after subtracting the premium.
Importance in Business or Economics
- Enables hedging against rising asset prices.
- Provides leverage for traders with limited capital.
- Used in employee compensation plans.
- Supports efficient price discovery in financial markets.
Types or Variations
- American Call Options (exercisable anytime)
- European Call Options (exercisable only at expiration)
- Long Call
- Covered Call
Related Terms
- Put Option
- Strike Price
- Option Premium
- Delta (Options Greeks)
Sources and Further Reading
- Investopedia – Call Option: https://www.investopedia.com/terms/c/calloption.asp
- CBOE Options Guide
- CFA Institute – Options and Derivatives
Quick Reference
- Buyer Goal: Profit from price increases.
- Seller Risk: Unlimited upside exposure.
- Key Inputs: Strike price, premium, expiration.
Frequently Asked Questions (FAQs)
How does a call option make money?
It becomes profitable when the underlying asset’s market price exceeds the strike price by more than the premium paid.
Can call options expire worthless?
Yes—if the asset price stays below the strike price.
Are call options risky?
For buyers, risk is limited to the premium. For sellers, risk can be significantly higher.
