Call Option

Option giving the right to buy an asset at a strike price before expiration.

A call option is a financial contract that gives the buyer the right, but not the obligation, to purchase a specific underlying asset—such as a stock—at a predetermined price (the strike price) within a set timeframe. For this right, the buyer pays a fee called the premium to the seller (or writer) of the option. If the underlying asset's price does not rise above the strike price before the option expires, the contract becomes worthless, and the buyer's loss is limited to the premium paid. Investors typically buy call options when they expect the price of the underlying asset to rise significantly. This strategy offers leverage, allowing investors to control a large number of shares for a fraction of the cost of buying the shares outright. Conversely, investors might sell (write) call options to generate income from the premiums if they expect the underlying asset's price to remain flat or decline slightly. A key risk for call option buyers is time decay, meaning the option's value decreases as the expiration date approaches, even if the underlying stock price remains unchanged. Additionally, if the stock price does not exceed the strike price by expiration, the option expires out-of-the-money, resulting in a 100% loss of the premium paid. For sellers of uncovered (naked) call options, the risk is theoretically unlimited because there is no cap on how high a stock's price can rise.

An investor buys a call option for Company XYZ with a strike price of $100 for a premium of $5 per share. Since one standard options contract represents 100 shares, the total premium paid is $500 ($5 x 100). If Company XYZ's stock price rises to $120 before expiration, the investor can exercise the option to buy the shares at $100 and immediately sell them at the market price of $120. The gross profit is $20 per share ($120 - $100), and after subtracting the $5 premium, the net profit is $15 per share, or $1,500 total ($15 x 100).