Derivatives

What is Call Option?

Definition

A call option gives the buyer the right to purchase the underlying asset at the strike price before expiration. Calls are used when an investor expects the price to rise. The maximum loss for the buyer is the premium paid.

Detailed Explanation

When you buy a call option, you profit when the underlying stock rises above the strike price plus the premium paid (the breakeven point). For example, a $100 strike call purchased for $5 breaks even at $105. Above $105, every dollar of stock appreciation is profit.

Call options provide leveraged upside exposure. Instead of buying 100 shares at $100 ($10,000), you can control 100 shares with a call option for perhaps $500 (the premium). If the stock rises to $120, your call is worth $20 per share ($2,000), a 300% return versus a 20% return on the stock.

Selling (writing) call options is a different strategy. Covered calls involve selling calls against owned stock, generating income from the premium but capping upside. Naked calls (selling calls without owning the stock) have theoretically unlimited risk and are not recommended for individual investors.

Call options are categorized as in-the-money (stock price above strike), at-the-money (stock price near strike), and out-of-the-money (stock price below strike). ITM calls have more intrinsic value and less leverage. OTM calls are cheaper but have higher probability of expiring worthless.

Frequently Asked Questions

When should I buy a call option?

Buy calls when you are bullish on a stock and want leveraged upside exposure with limited downside risk. Calls are also used to lock in a purchase price for a stock you plan to buy. Consider the time horizon and implied volatility level.

What is a covered call?

A covered call involves owning 100 shares of a stock and selling a call option against it. You earn the premium as income but cap your upside at the strike price. It is a popular strategy for generating income on existing holdings.

What happens when a call option expires?

If the stock is above the strike price at expiration, the call is exercised and you buy 100 shares at the strike. If below, the call expires worthless and you lose only the premium paid. Most traders close positions before expiration.

Related Terms

Strike Price

The strike price (or exercise price) is the predetermined price at which an option holder can buy (for calls) or sell (for puts) the underlying asset. It is the most important factor in determining an option's value and risk/reward profile.

Implied Volatility (IV)

Implied volatility is the market's forecast of the likely magnitude of a stock's price movement, derived from option prices. High IV means options are expensive because the market expects large price swings, while low IV means options are cheap because calm conditions are expected.

Options

Options are financial contracts that give the buyer the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a specified price (strike) before a specified date (expiration). They are used for speculation, hedging, and income generation.

Put Option

A put option gives the buyer the right to sell the underlying asset at the strike price before expiration. Puts are used when an investor expects the price to fall or wants to protect against downside risk in existing holdings.

See It in Action

Apple

Microsoft

Johnson & Johnson

Berkshire Hathaway

Disclaimer: The information on this page is provided for educational and informational purposes only and does not constitute investment advice. AI-generated analysis may contain errors or inaccuracies. Always conduct your own research and consult a qualified financial advisor before making investment decisions.