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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
A call option is a financial instrument that gives the buyer the right, but not an obligation, to buy a set quantity of a security at a set strike price at some time on or before expiration. In this sense, a call option is very similar to a warrant. The decision of the best time to exercise the call depends on whether it is an American option or European option. If and when the buyer decides to exercise the option, the counterparty who sold, or wrote the call must sell to the buyer the security at the agreed-upon strike price, even if the security's market price has risen above the strike price.
In other words, when you buy a call option, you are buying the right to buy a stock at the strike price, regardless of the stock price in the future before the expiration date. For example, if a stock trades at $50 right now and you buy its call option with a $50 strike price, you have the right to purchase that stock for $50 regardless of the current stock price as long as it has not expired. Even if the stock rises to $100, you still have the right to buy that stock for $50 as long as the call option has not expired. Since the payoff of purchased call options increases as the stock price rises, buying call options is considered bullish.
Conversely, you can short or "write" the call option, giving the buyer the right to buy that stock from you for $50 anytime before the option expires. To compensate you for that risk taken, the buyer pays you a premium, also known as the price of the call. The seller of the call is said to have shorted the call option, and keeps the premium (the amount the buyer pays to buy the option) whether or not the buyer ever exercises the option. If the stock falls to below $50, the buyer will never exercise the option, since he would have to pay $50 per share when he can buy the same stock for less. If this occurs, the option expires worthless and the option seller keeps the premium as profit. Since the payoff for sold, or written call options increases as the stock price falls, selling call options is considered bearish.
All call options have the following three characteristics:
- Strike price: this is the price at which you can buy the stock (if you have bought a call option) or the price at which you must sell your stock (if you have sold a call option).
- Expiry date: this is the date on which the option expires, or becomes worthless, if the buyer doesn't exercise it.
- Premium: this is the price you pay when you buy an option and the price you receive when you sell an option.
See also:
External Links
- Call Options by Optiontradingpedia.com
- Covered Call Tutorial by BornToSell.com
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