What is a Call Option?

what is a call option

Definition of Call Option

What Is It?

A call option is a financial agreement that provides the purchaser the ability, but not the duty, to purchase a stock, commodity, bond, or other asset or product at a given price within a certain time frame. The underlying asset is a stock, commodity, or bond. Whenever the value of the underlying asset rises, the call buyer benefits.

A put option, on the other hand, grants the holder the authority to sell the underlying asset at a certain price on or before the expiration date. 

The Conception of a Call Option

Suppose the underlying asset is a share of stock. The owner of a call option has the ability to acquire 100 shares of a firm at a given price, termed as the strike price, till a given date, termed as the expiry date.

 Just one call option contract, for instance, would provide the owner the right to buy 100 shares of Microsoft stock at $100 until the contract expires in 3 months. Traders can pick from a variety of expiry dates and strike prices. The price of the option contract rises when the price of Microsoft stock rises, and opposite. The call option purchaser can keep the agreement until it expires, at which point he or she can either accept possession of the 100 shares of stock or trade the options agreement at any given time before the expiry date for the current market price.

You must purchase a premium in order to acquire a call option. It is the amount charged for the benefits granted by the call option. The call purchaser loses the payment if the underlying asset is under the strike price at expiration. This is the largest amount of money lost.

The profit is the gap between the prices, minus the premium if the underlying asset’s present market value is higher than the strike price at expiry. The total is then multiplied by the number of shares controlled by the option purchaser.

Different Purposes of Call Options

Income Purposes

A covered call strategy is used by some traders to make money from call options. This approach entails holding an underlying stock while also issuing a call option, which allows somebody to acquire your shares. The option payment is collected, and the trader expects the option will expire undervalued (below strike price). This technique provides the trader with extra income, but it might also restrict potential profit if the underlying stock value climbs rapidly.

Covered calls succeed since the purchaser will use their ability to purchase the stock at the significantly lower strike price if the stock climbs over the strike price. This indicates that if the stock rises over the strike price, the option issuer loses money. The premium paid represents the options issuer’s best available profit on the option.

Speculation Purposes

Options contracts allow investors to gain considerable exposure to a stock for a reasonably low cost. If a stock increases, it can generate huge returns if it’s used alone.  However, if the call option’s term is up and it is worthless, owing to the underlying share value failing to rise above the strike price, the premium will be lost completely. Purchasing call options have the advantage of limiting risk to the price paid for the option.

A call spread is formed when an investor buys and sells various call options at the same time. These will limit the technique’s prospective profit and loss, but they may be more cost-effective in certain situations rather than just one call option because the premium earned from one option’s selling compensates the premium paid for another.

Why Are the Investors Interested in Call Options?

If traders are positive or “bullish” regarding the possibilities of the underlying asset, many will probably purchase call options. Due to the leverage that calls options give, they may be a more appealing tool for such investors to bet on the future prospects of the firm. And besides, every options contract allows you to purchase 100 shares of that firm. Purchasing shares via call options might be an appealing approach to improve purchasing power for a trader who is certain that a company’s shares will grow.

SEE ALSO: How to Use High Leverage in Forex Trading?

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Caroline Tetra

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