Definition of Call Option§
A call option is a type of options contract that gives the buyer the right, but not the obligation, to buy a specific quantity of an underlying asset at a predetermined price (known as the strike price) within a specified time frame. Investors purchase call options when they anticipate that the price of the underlying asset will increase. The seller of the call option, also known as the writer, is obliged to sell the asset if the buyer decides to exercise the option.
Examples§
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Stock Call Option: An investor buys a call option for Company XYZ’s stock with a strike price of $50, expiring in three months. If the stock price rises to $60 before expiration, the investor can buy the stock at $50 and potentially sell it at $60, making a profit.
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Real Estate Call Option: A speculative real estate investor enters into a call option to purchase a plot of land for $200,000 within the next year. If the area’s land values increase and the land is now worth $250,000, the investor can exercise the option, buy it at $200,000, and sell it at the market value.
Frequently Asked Questions§
1. What is the difference between a call option and a put option?§
- A call option gives the owner the right to buy an asset at a specific price within a certain time frame, while a put option gives the owner the right to sell an asset under the same conditions.
2. Why would an investor buy a call option?§
- An investor might buy a call option to speculate on the price increase of an asset or to hedge against potential price increases for assets they need to purchase in the future.
3. What happens when a call option expires?§
- If a call option is not exercised by its expiration date, it becomes worthless, and the option buyer loses the premium paid. If exercised, the buyer can purchase the asset at the strike price.
4. Can a call option be sold before it expires?§
- Yes, a call option can be sold before expiration in the options market, allowing the owner to capture any potential profit if the market price of the option has increased.
5. Are call options more affordable than buying stocks outright?§
- Yes, call options typically require a smaller upfront investment (the premium) compared to buying the underlying stock outright, allowing investors to control a large number of shares with less capital.
Related Terms§
- Strike Price: The fixed price at which the owner of a call option can purchase the underlying asset.
- Premium: The amount paid by the buyer to the seller for the call option.
- Expiration Date: The date on which the call option expires and can no longer be exercised.
- In-the-Money: When the current price of the underlying asset is above the strike price of the call option.
- Out-of-the-Money: When the current price of the underlying asset is below the strike price of the call option.
- Option Writer: The seller of the call option who has the obligation to sell the underlying asset if the option is exercised.
Online Resources§
References§
- Hull, John C. “Options, Futures, and Other Derivatives.” Pearson Education, 10th Edition, 2017.
- McMillan, Lawrence G. “Options as a Strategic Investment.” New York Institute of Finance, 5th Edition, 2012.
- Natenberg, Sheldon. “Option Volatility and Pricing: Advanced Trading Strategies and Techniques.” McGraw-Hill Education, 2nd Edition, 1994.
Suggested Books for Further Studies§
- “Options Trading for Dummies” by Joe Duarte
- “Trading Options Greeks: How Time, Volatility, and Other Pricing Factors Drive Profit” by Dan Passarelli
- “Option Volatility and Pricing: Advanced Trading Strategies and Techniques” by Sheldon Natenberg
- “Options as a Strategic Investment” by Lawrence G. McMillan
