Call Options: What They Are and How They Work

Since your options contract is a right, and not an obligation, to purchase ABC shares, you can choose to not exercise it, meaning you will not buy ABC’s shares. Your losses, in this case, will be limited to the premium you paid for the option. It is the price paid for the rights that the call option provides. If at expiration the underlying asset is below the strike price, the call buyer loses the premium paid.

The investor collects the option premium and hopes the option expires worthless (below strike price). This strategy generates additional income for the investor but can also limit profit potential if they are forced to prematurely sell their stock if the underlying stock price rises sharply. Call options are a type of derivative contract that gives the holder the right but not the obligation to purchase a specified number of shares at a predetermined price, known as the “strike price” of the option. If the market price of the stock rises above the option’s strike price, the option holder can exercise their option, buying at the strike price and selling at the higher market price in order to lock in a profit. Options contracts give buyers the opportunity to obtain significant exposure to a stock for a relatively small price. Used in isolation, they can provide significant gains if a stock rises.

How does a call option work?

Due to the high degree of leverage, call options are considered high-risk investments. Alternatively, if the price of the underlying security rises above the option strike price, the buyer can profitably exercise the option. The seller of the option is obligated to sell the security to the buyer if the latter decides to exercise their option to make a purchase. The buyer of the option can exercise the option at any time prior to a specified expiration date. The expiration date may be three months, six months, or even one year in the future. Suppose you purchase a call option for company ABC for a premium of $2.

• Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies.
• Call options might provide a more attractive way to speculate on the prospects of a company because of the leverage that they provide.
• Used in isolation, they can provide significant gains if a stock rises.
• Not wanting to trigger a taxable event, this investor may utilize options to reduce the exposure to the underlying security without actually selling it.

Owning a call option contract is not the same as owning the underlying stock. A call option contract gives you the right to buy 100 shares of the underlying stock for the strike price for a predetermined period of time until the expiration date of the contract. It’s important to note that exercising is not the only way to turn an options trade profitable.

Put options: Learn the basics of buying and selling

You take a look at the call options for the following month and see that there’s a 115 call trading at 37 cents per contract. You own 100 shares of the stock and want to generate an income above and beyond the stock’s dividend. Though options profits will be classified as short-term capital gains, the method for calculating the tax liability will vary by the exact option strategy and holding period. A call option may be contrasted with a put option, which gives the holder the right to sell the underlying asset at a specified price on or before expiration. For this option to buy the stock, the call buyer pays a “premium” per share to the call seller.

So, whether you’re reading an article or a review, you can trust that you’re getting credible and dependable information. We are an independent, advertising-supported comparison service. The option versus obligation to buy the asset lets you wait and see.

Learn more about options

Their profits from many premiums on the options they guess correctly outweigh the occasional losses on an option that goes against them. These corporations have analysts with computer programs that figure all this out for them. There is no limit to your potential loss on naked calls since there’s no limit on how high an asset’s price can rise.

You’ve got to hope that the fee you charge is more than enough to pay for your risk. Generally, traditional options contracts expire on the third Friday of each month. The investment information provided in this table is for informational and callable option meaning general educational purposes only and should not be construed as investment or financial advice. Bankrate does not offer advisory or brokerage services, nor does it provide individualized recommendations or personalized investment advice.

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This strategy is used when a trader expects a decline in the price of the underlying asset. In this case, the calls sold at a lower strike price will always generate more income than the calls bought at a higher one. If the market price of the underlying asset is lower than the strike price of the calls sold, you keep the cash. If it trades higher, the purchased calls reduce the upside risk.

A call option is a contract between two parties that gives the call’s buyer the right to buy the underlying security, commodity, or contract. Also defined in the contract are the terms of this transaction—the defined price at which it would take place (strike price) and the time period for its execution (exercise date). A “long call” is a purchased call option with an open right to buy shares. What happens when ABC’s share price declines below $50 by Nov. 30?

Our partners cannot pay us to guarantee favorable reviews of their products or services. Operating income is a measure of the money that a business makes from its primary operations, minus the expenses it incurs to make that money, such as wages and cost of goods sold. They give you the right to buy a specific quantity of an exact item, for a certain price, before the coupon expires.

Your risk is now $5,500, plus the amount you paid for the option, which was $200. So, if XYZ goes out of business and the stock goes to $0, you will have potentially lost $5,700 on the entire investment. If the stock rises above the strike price, the call option you bought is said to be in the money (ITM) — You have the right to buy the stock at the strike price even though it’s worth more in the open market. Generally speaking, most options traders choose #2; selling their call option for the fair market value of $5, keeping the $300 profit, and forgoing their right to buy the stock at $55. Conversely, “out of the money” call options are those whose underlying asset price is below the strike price, making the option more riskier but also cheaper. In this situation, the seller, also known as a call writer, is the one with the obligation and will have to sell the asset at the strike price if the buyer decides to exercise the option.

Call options are financial contracts that give the option buyer the right but not the obligation to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period. A call buyer profits when the underlying asset increases in price. A call option seller can generate income by collecting premiums from the sale of options contracts.

Definition and Examples of a Call Option

For example, assume you bought an option on 100 shares of a stock, with an option strike price of $30. Before your option expires, the price of the stock rises from $28 to $40. Then you could exercise your right to buy 100 shares of the stock at $30, immediately giving you a $10 per share profit. Buying calls is a bullish strategy because the buyer only profits if the price of the shares rises.

• Potential losses theoretically are infinite if the stock price continued to rise, so call sellers could lose more money than they received from their initial position.
• The value of shares and ETFs bought through a share dealing account can fall as well as rise, which could mean getting back less than you originally put in.
• A call option may be contrasted with a put option, which gives the holder the right to sell the underlying asset at a specified price on or before expiration.
• If the buyer exercises the option, you have to buy the asset at the market price to satisfy the order.
• Because one contract represents 100 shares, for every $1 increase in the stock price above the strike price, the total value of the option increases by $100.

For example, an investor owns 100 shares of XYZ stock and is liable for a large unrealized capital gain. Not wanting to trigger a taxable event, this investor may utilize options to reduce the exposure to the underlying security without actually selling it. The only cost to the shareholder for engaging in this strategy is the cost of the options contract itself. Covered calls work because if the stock rises above the strike price, the option buyer will exercise their right to buy the stock at the lower strike price.