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call option: Definition and Much More from Answers.com

  • ️Wed Jul 01 2015

This article is about financial options. For call options in general, see Option (law).

Buying a call option - This is a graphical interpretation of the payoffs and profits generated by a call option as seen by the buyer. A higher stock price means a higher profit. Eventually, the price of the underlying security will be high enough to fully compensate for the price of the option.

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Buying a call option - This is a graphical interpretation of the payoffs and profits generated by a call option as seen by the buyer. A higher stock price means a higher profit. Eventually, the price of the underlying security will be high enough to fully compensate for the price of the option.

Writing a call option - This is a graphical interpretation of the payoffs and profits generated by a call option as seen by the writer of the option. Profit is maximized when the strike price exceeds the price of the underlying security, because the option expires worthless and the writer keeps the premium.

Enlarge

Writing a call option - This is a graphical interpretation of the payoffs and profits generated by a call option as seen by the writer of the option. Profit is maximized when the strike price exceeds the price of the underlying security, because the option expires worthless and the writer keeps the premium.

A call option is a financial contract between two parties, the buyer and the seller of this type of option. Often it is simply labeled a "call". The buyer of the option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.

The buyer of a call option wants the price of the underlying instrument to rise in the future; the seller either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for (a) the premium (paid immediately) plus (b) retaining the opportunity to make a gain up to the strike price (see below for examples).

Call options are most profitable for the buyer when the underlying instrument is moving up, making the price of the underlying instrument closer to the strike price. When the price of the underlying instrument surpasses the strike price, the option is said to be "in the money".

The initial transaction in this context (buying/selling a call option) is not the supplying of a physical or financial asset (the underlying instrument). Rather it is the granting of the right to buy the underlying asset, in exchange for a fee - the option price or premium.

Exact specifications may differ depending on option style. A European call option allows the holder to exercise the option (i.e., to buy) only on the option expiration date. An American call option allows exercise at any time during the life of the option.

Call options can be purchased on many financial instruments other than stock in a corporation - options can be purchased on futures on interest rates, for example (see interest rate cap) - as well as on commodities such as gold or crude oil. A tradeable call option should not be confused with either Incentive stock options or with a warrant. An incentive stock option, the option to buy stock in a particular company, is a right granted by a corporation to a particular person (typically executives) to purchase treasury stock. When an incentive stock option is exercised, new shares are issued. Incentive stock options are not traded on the open market. In contrast, when a call option is exercised, the underlying asset is transferred from one owner to another.

See also

Options

External links

Derivatives market
Derivative (finance)
Options
Swaps
Other derivatives

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