Call options are a financial instrument used by investors to speculate on the future value of an underlying asset. It’s important for business professionals to understand the concept of call options, and this comprehensive guide will help answer any questions you may have.
What Is a Call Option?
A call option is a contract between a buyer and a seller. The buyer has the right to buy a security at a set price (strike price) on or before a certain date (expiration date). The seller has the obligation to sell the security to the buyer on or before the expiration date at the strike price. If the security does not reach (or surpass) the strike price on or before the expiration date, the buyer has no obligation to purchase the security and the option expires.
How Does a Call Option Work?
- The buyer of the call option pays the seller a fee known as a premium.
- If the security does reach or surpass the strike price on or before the expiration date, the buyer would purchase the security at the strike price and keep any gains made.
- The seller would have to hand over the security to the buyer at the strike price.
- The maximum profit and loss for the buyer of a call option is known in advance.
Examples of Call Options
A classic example of a call option is to purchase stock of a company. Suppose the stock of a company is currently trading at $100 per share. The buyer of the call option can purchase a call option for $2 per share with the strike price of $110 and an expiration date of two months. If the stock of the company rises above $110 per share before the expiration date, then the buyer will purchase the stock at the strike price of $110 and make a profit of $8 per share ($110 – $100 – $2 = $8). If the stock does not reach or surpass the strike price before the expiration date, then the buyer will not purchase the stock, the option will expire, and the buyer will lose the premium.
Conclusion
Call options are a useful way for investors to speculate on the price of a security. By understanding how a call option works, business professionals can use them as a tool to make informed decisions when investing in the stock market.