Call Option

Published Aug 4, 2023

Definition of Call Option

A call option is a financial contract that gives the buyer the right, but not the obligation, to buy a certain asset at a predetermined price (the strike price) within a certain period of time. That means the buyer of the call option has the right to buy the underlying asset at the strike price but is not obligated to do so.

Example

To illustrate this, let’s look at an example. Imagine Joe is a stock trader and he believes that the stock of XYZ Corporation is going to increase in the near future. To benefit from this potential increase, Joe buys a call option on XYZ Corporation with a strike price of $50. That means Joe has the right to buy 100 shares of XYZ Corporation at $50 per share within the next three months.

Now, if the stock of XYZ Corporation increases to $60 per share within the next three months, Joe can exercise his option and buy 100 shares of XYZ Corporation at $50 per share. That means he can buy the shares for $50 and immediately sell them for $60, thus making a profit of $10 per share.

Why Call Options Matter

Call options are an important financial instrument for traders and investors. They allow them to benefit from potential price increases without having to buy the underlying asset. That means they can speculate on the price of an asset without having to put up the full amount of money needed to buy it.

In addition, call options also provide traders with a certain degree of protection against potential losses. That is because the maximum loss a trader can incur is limited to the amount of money he paid for the option.