Call Option
IntermediateA call option is a contract that gives its buyer the right, but not the obligation, to buy an asset at a set price, the strike price, on or before a specific date.
The buyer of a call pays a premium for the right to buy. They benefit if the price of the underlying asset rises above the strike price.
Suppose you buy a call option on a share with a strike price of 50, paying a premium of 3 per share, for a contract covering 100 shares. If the share price rises to 58 by expiry, you can buy at 50 and the option is worth 8 per share. After subtracting the premium, your profit is 5 per share, or 500 in total. Your break-even price is 53, the strike plus the premium.
If the share price stays at or below 50, you let the option expire and lose the premium of 300. The buyer's maximum loss is limited to the premium, while the potential gain is, in principle, unlimited.
The seller of the call receives the premium but must sell the shares at 50 if the buyer exercises, however high the price has gone.
Call options are used to benefit from expected price rises with limited downside, and companies use similar instruments to reward employees. Selling calls against shares you own, called a covered call, is a way to earn income.
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