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A call option is a financial contract between two parties, the buyer and the seller of this type of option
Option (finance)

In finance, an option is a contract between a buyer and a seller that gives the buyer the right?but not the obligation?to buy or to sell a particular asset at a later time at an agreed price....
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Calloption
Callwrite


A call option is a financial contract between two parties, the buyer and the seller of this type of option
Option (finance)

In finance, an option is a contract between a buyer and a seller that gives the buyer the right?but not the obligation?to buy or to sell a particular asset at a later time at an agreed price....
. It is the option to buy shares of stock at a specified time in the future.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
Commodity

A commodity is anything for which there is demand, but which is supplied without qualitative product differentiation across a market. It is a product that is the same no matter who produces it, such as petroleum, notebook paper, or milk....
 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
Strike price

In option , the strike price, or exercise price, is a key variable in a derivative contract between two parties. Where the contract requires delivery of the underlying instrument, the trade will be at the strike price, regardless of the spot price of the underlying instrument at that time....
). 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 the premium (paid immediately) and 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
Option style

In finance, the style or family of an option is a general term denoting the class into which the option falls, usually defined by the dates on which the option may be Exercise ....
. 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 rate
Interest rate

An interest rate is the price a borrower pays for the use of money they do not own, for instance a small company might borrow from a bank to kick start their business, and the return a lender receives for deferring the use of funds, by lending it to the borrower....
s, for example (see interest rate cap), and on commodities like gold
Gold

Gold is a chemical element with the symbol Au and atomic number 79. It is a highly sought-after precious metal, having been used as money, as a store of value, in jewelry, in sculpture, and for ornamentation since the beginning of recorded history....
 or crude oil. A tradeable call option should not be confused with either Incentive stock options or with a warrant
Warrant (finance)

In finance, a warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue....
. An incentive stock option, the option to buy stock
STOCK

Software for fixed assets management and stock control developed in 2004. Stocktaking process is carried using a hand-held mobile terminal equipped with barcode reader or RFID technology....
 in a particular company, is a right granted by a corporation to a particular person (typically executives) to purchase treasury stock
Treasury stock

A treasury stock or reacquired stock is stock which is bought back by the issuing company, reducing the amount of outstanding stock on the open market ....
. 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.

Example of a call option on a stock


Buy a call: The buyer expects that the price may go up. The buyer pays a premium that will never be refunded. He has the right to exercise the option at the strike price.

Write a call: The writer receives the premium. If the buyer decides to exercise the option, then the writer has to sell the stock at the strike price. If the buyer does not exercise the option, then the writer profits the premium.

  • 'Trader A' (Call Buyer) purchases a Call contract to buy 100 shares of XYZ Corp from 'Trader B' (Call Writer) at $50/share. The current price is $45/share, and 'Trader A' pays a premium of $5/share. If the share price of XYZ stock rises to $60/share right before expiration, then 'Trader A' can exercise the call by buying 100 shares for $5,000 from 'Trader B' and sell them at $6,000 in the stock market.


Trader A's total earnings (S) can be calculated at $500. Sale of 100 stock at $60 = $6,000 (P) Amount paid to 'Trader B' for the 100 stock bought at strike price of $50 = $5,000 (Q) Call Option premium paid to Trader B for buying the contract of 100 shares @ $5/share, excluding commissions = $500 (R)

S=P-(Q+R)=$6,000-($5,000+$500)=$500'

  • If, however, the price of XYZ drops to $40/share below the strike price, then 'Trader A' would not exercise the option. (Why buy a stock from 'Trader B' at 50, the strike price, when it can be bought at $40 in the stock market?) Trader A's option would be worthless and the whole investment, the fee (premium) for the option contract, $500 (5/share, 100 shares per contract). Trader A's total loss is limited to the cost of the call premium plus the sales commission to buy it.


This example illustrates that a call option has positive monetary value when the underlying instrument has a spot price
Spot price

The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate Settlement . Spot settlement is normally one or two business days from trade date....
 (S) above the strike price (K). Since the option will not be exercised unless it is "in-the-money", the payoff for a call option is

or, more formally,

where


Prior to exercise, the option value, and therefore price, varies with the underlying price and with time. The call price must reflect the "likelihood" or chance of the option "finishing in-the-money". The price should thus be higher with more time to expire (except in cases when a significant dividend is present) and with a more volatile
Volatility (finance)

Volatility most frequently refers to the standard deviation of the continuously compounded returns of a financial instrument with a specific time horizon....
 underlying instrument. The science of determining this value is the central tenet of financial mathematics. The most common method is to use the Black-Scholes
Black-Scholes

The term Black?Scholes refers to three closely related concepts:* The #Black?Scholes model is a mathematical model of the market for an Stock, in which the equity's price is a stochastic process....
 formula. Whatever the formula used, the buyer and seller must agree on the initial value (the premium), otherwise the exchange (buy/sell) of the option will not take place.

See also

  • Covered call
    Covered call

    A covered call is a transaction in which the seller of call options already owns the corresponding amount of the underlying instrument, such as shares of a stock or other securities....
  • Moneyness
    Moneyness

    In finance, moneyness is a measure of the degree to which a derivative is likely to have positive monetary value at its expiration, in the risk-neutral measure....
  • Naked call
    Naked call

    A Naked Call occurs when a speculator writes a call option on a security without ownership of that security. It is one of the riskiest options strategies because it carries unlimited risk as opposed to a naked put where the maximum loss occurs if the stock falls to zero....
  • Naked put
    Naked put

    A put option is a contract that gives the buyer the right, but not the obligation, to sell an underlying security to the writer of the option at an agreed-upon strike price within a certain period or on a specific date....
  • Option
    Option (finance)

    In finance, an option is a contract between a buyer and a seller that gives the buyer the right?but not the obligation?to buy or to sell a particular asset at a later time at an agreed price....
  • Option time value
    Option time value

    In finance, the value of an option consists of two components, its intrinsic value and its time value. Time value is simply the difference between option value and intrinsic value....
  • Option style
    Option style

    In finance, the style or family of an option is a general term denoting the class into which the option falls, usually defined by the dates on which the option may be Exercise ....
  • Pre-emption right
    Pre-emption right

    A pre-emption right is a right to acquire certain property in preference to any other person. It usually refers to property newly coming into existence....
  • Put option
    Put option

    A put option is a finance contract between two parties, the seller and the buyer of the option . The buyer acquires a long position offering the right, but not obligation, to sell the underlying instrument at an agreed-upon price ....
  • Put-call parity
  • Right of first refusal
    Right of first refusal

    Right of first refusal is a contractual right that gives its holder the option to enter a business transaction with the owner of something, according to specified terms, before the owner is entitled to enter into that transaction with a third party....

Options

  • Binary option
    Binary option

    In finance, a binary option is a type of Option where the payoff is either some fixed amount of some asset or nothing at all. The two main types of binary options are the cash-or-nothing binary option and the asset-or-nothing binary option....
  • Bond option
    Bond option

    In finance, a bond option is an OTC-traded financial instrument that facilitates an option to buy or sell a particular bond at a certain date for a particular price....
  • Credit default option
    Credit default option

    In finance, a default option, credit default swaption or credit default option is an option to buy protection or sell protection as a credit default swap on a specific reference credit with a specific maturity....
  • Exotic interest rate option
  • Foreign exchange option
    Foreign exchange option

    In finance, a foreign exchange option is a derivative financial instrument where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date....
  • Interest rate cap and floor
    Interest rate cap and floor

    Interest rate capAn interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price....
  • Options on futures
    Futures contract

    In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a standardized quantity of a specified commodity of standardized quality at a certain date in the future, at a price determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders...
  • Stock option
  • Swaption
    Swaption

    A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap . Although options can be traded on a variety of swaps, the term "swaption" typically refers to options on interest rate swaps....
  • Warrant
    Warrant (finance)

    In finance, a warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue....