Call Options

Call options are agreements that give an investor the right, but not the obligation, to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period.

The agreed upon price of the exchange is called the strike price. The date on which the agreement expires is the expiry date of the call option. The amount of money required to purchase this call option is called the premium. If the exchange takes place, then one is said to have exercised the call option.

If you choose to buy or go long a call option, you are purchasing the right to buy the underlying instrument at whatever strike price you choose until the expiration date.

A trader who believes that a stock’s price will increase might buy the right to purchase the stock (a call option) rather than just buy the stock. If the stock price at expiration is above the exercise price by more than the premium (price) paid, he will profit. If the stock price at expiration is lower than the exercise price, he will let the call contract expire worthless, and only lose the amount of the premium. A trader might buy the option instead of shares, because for the same amount of money, he can obtain a much larger number of options than shares. If the stock rises, he will thus realize a larger gain than if he had purchased shares.

If you choose to sell or go short a call option, you are selling the right to buy the underlying instrument at a particular strike price to an option holder.

A trader who believes that a stock price will decrease, can sell the stock short or instead sell, or “write,” a call. The trader selling a call has an obligation to sell the stock to the call buyer at the buyer’s option. If the stock price decreases, the short call position will make a profit in the amount of the premium. If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money, with the potential loss unlimited.

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