A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.
The buyer of a call option purchases it in the hope that the price of the underlying instrument will rise in the future. The seller of the option either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples).
Call options are most profitable for the buyer when the underlying instrument moves up, making the price of the underlying instrument closer to, or above, the strike price. The call buyer believes it's likely the price of the underlying asset will rise by the exercise date. The risk is limited to the premium. The profit for the buyer can be very large, and is limited by how high the underlying instrument's spot price rises. When the price of the underlying instrument surpasses the strike price, the option is said to be "in the money".
The call writer does not believe the price of the underlying security is likely to rise. The writer sells the call to collect the premium and does not receive any gain if the stock rises above the strike price.
The initial transaction in this context (buying/selling a call option) is not the supplying of a physical or financial asset (the underlying instrument). Rather it is the granting of the right to buy the underlying asset, in exchange for a fee — the option price or premium.
Exact specifications may differ depending on option style. A European call option allows the holder to exercise the option (i.e., to buy) only on the option expiration date. An American call option allows exercise at any time during the life of the option.
Call options can be purchased on many financial instruments other than stock in a corporation. Options can be purchased on futures on interest rates, for example (see interest rate cap), and on commodities like gold or crude oil. A tradeable call option should not be confused with either Incentive stock options or with a warrant. An incentive stock option, the option to buy stock in a particular company, is a right granted by a corporation to a particular person (typically executives) to purchase treasury stock. When an incentive stock option is exercised, new shares are issued. Incentive stock options are not traded on the open market. In contrast, when a call option is exercised, the underlying asset is transferred from one owner to another.
Read more about Call Option: Example of A Call Option On A Stock, Example of Valuing A Stock Option, Value of A Call, Price of Options, Options
Famous quotes containing the words call and/or option:
“You must call up every strength you own
And you can rip off the whole facial mask.”
—William Dewitt Snodgrass (b. 1926)
“A self-respecting nation is ready for anything, including war, except for a renunciation of its option to make war.”
—Simone Weil (1909–1943)