Call options (or "calls") give you the right, but not the
obligation, to buy an underlying security at a specific price for a
fixed period of time. Traders may buy calls when they believe an
underlying security (e.g., a particular stock or an index) will rise in
price. If they wish to sell the underlying security, they must do so
before the option expires on a predetermined expiration date.
The financial risk of buying a call is limited to the
premium paid for the option. If the option expires worthless, the premium
will be lost (assuming the put option was not sold to another trader prior
to expiration). If the price of the underlying stock or index moves higher,
that is to say, above the strike price, the call buyer can make a profit.
A call seller, also called the "writer", takes on the
obligation of selling an underlying security from the call buyer at a
predetermined strike price, up until a specified expiration date. Call
sellers make money by collecting option premiums from put buyers. If a call
expires worthless (i.e., if the call buyer cannot exercise the call option
at a profit), the call writer keeps the premium.
A simple example illustrates how calls may be used:
Assume the current price of a particular stock is $30.
Also assume that you buy a call, which gives you the right, but not the
obligation, to buy the underlying stock from the call writer at a strike
price of $30. You have the right to buy the stock at that price, as long as
the put has not yet expired; say for three months from today. For acquiring
this right, you paid a premium of $1 per contract (i.e., per 100 shares of
the underlying stock).
If after some time the stock has raised to $40, you may choose to exercise
your put option. The call seller must sell your stock for $30. (You could at
this point sell it for $40, pocketing the difference as your profit). In
this case, by investing $1 you are making $9 (900%).
On the other hand, if the stock moves down instead of up, say to $25, your
call will expire worthless. In this case, you lose the premium you paid
(100% of invested money) for the option while the call seller keeps the
premium he or she received from you.
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