What Is a Call Option?

What Is a Call Option?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A call option is a kind of contract used in the world of finance. In this type of contract, the owner of the option has the right to buy a specific amount of an asset, often stocks, at a set price within a defined period of time. The key here is that the option’s owner has the right to buy, but isn’t obligated. This essentially gives them optionality, meaning they can choose to exercise the option if it suits their financial goals or abandon it if it doesn’t. The price at which the option owner can buy the asset is known as the “strike price”, and the defined period of time is known as the “expiration date”.

Related Questions

1. How do call options work?

A call option works in a way where the buyer pays for the right (but not the obligation) to purchase an asset at an agreed price within a certain time frame. If the asset’s market price exceeds the option’s strike price before the expiration date, the buyer can exercise the option to buy at the lower price. If not, the option can expire worthless.

2. What is the difference between a call option and a put option?

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While a call option gives the holder the right to buy an asset at a certain price within a specific period, a put option gives the holder the right to sell an asset at an agreed-upon price within a certain timeframe. They basically work in opposite ways in relation to the movement of the asset’s price.

3. How does one make money from a call option?

A call option buyer can profit in two ways. First, by exercising the option when the market price of the underlying asset goes above the strike price. Second, by selling the option to someone else before it expires, especially if the premium value has increased due to the rise of the underlying asset’s price.

4. What are the risks involved with call options?

The risk of buying a call option is limited to the premium that the buyer pays to the seller. If the market price of the asset doesn’t rise above the strike price before the expiration, the option can expire worthless, and the premium paid would be lost. But the profit potential is theoretically unlimited if the asset’s price continues to rise.

5. What does it mean to ‘exercise’ a call option?

To ‘exercise’ a call option means to use the right given by the option to buy the underlying asset at the strike price. This is usually done when the market price of the asset has risen above the strike price, allowing the option holder to buy at the lower strike price.