Explanation:Basically, it’s a contingent purchase agreement between someone who owns a security and someone who wants to purchase it. The current owner of the securities is paid a premium and agrees to allow the prospective owner to purchase the securities at a specific price, called the strike price , before a specific date, the contract maturity date. Although a call-option gives the option owner the right to purchase the securities, he is not obligated to exercise his call on or before the contract matures. He simply has the right, or option, to purchase the asset from the owner. On the other hand, the option seller is obliged to sell the securities on or before maturity if the option holder chooses to exercise his right. Call options are exercised at the strike price, and investors realize a profit if the strike price is higher than the market price of the underlying security. The maximum loss for a call-option is the premium paid for the option.
Example:George owns 100 shares of a technology company that trade at $87. George believes that the stock price will rise to $102 within the next 5 months, and he decides to buy a call option on the technology stock for $3 at a strike price of $100. He pays $300 for 100 shares (each option contract covers 100 shares).
In a nutshell :
- A call is an option contract giving the owner the right but not the obligation to buy a specified amount of an underlying security at a specified price within a specified time.
- The specified price is known as the strike price, and the specified time during which the sale can be made is its expiration or time to maturity.
- You pay a fee to purchase a call option, called the premium; this per-share charge is the maximum you can lose on a call option.
- You can go long on a call option by buying it or short a call option by selling it.
- Call options may be purchased for speculation or sold for income purposes or for tax management.
- Call options may also be combined for use in spread or combination strategies.