What is a Call Option?
A call option is a type of financial derivative that gives the holder the right, but not the obligation, to buy an underlying asset at a predetermined price (the strike price) on or before a specified date (the expiration date). The buyer of the call option pays a premium to the seller for the right to buy the asset.
Importance of Call Options
Call options are important financial instruments that allow investors to hedge their portfolios against potential losses. They also provide investors with the opportunity to speculate on the future price of an asset without having to actually purchase the asset. Call options are also used by companies to raise capital and by traders to speculate on the direction of the market.
Example of a Call Option
For example, let’s say that an investor buys a call option on a stock with a strike price of $50 and an expiration date of one month. If the stock price rises to $60 by the expiration date, the investor can exercise the option and buy the stock at the strike price of $50, making a profit of $10 per share. If the stock price falls to $40 by the expiration date, the investor can simply let the option expire and not buy the stock, thus avoiding any losses.
Table of Call Option
| Term | Definition |
| — | — |
| Call Option | A type of financial derivative that gives the holder the right, but not the obligation, to buy an underlying asset at a predetermined price (the strike price) on or before a specified date (the expiration date). |
| Strike Price | The predetermined price at which the underlying asset can be bought. |
| Expiration Date | The date on or before which the option must be exercised. |
Key Takeaways
- A call option is a type of financial derivative that gives the holder the right, but not the obligation, to buy an underlying asset at a predetermined price on or before a specified date.
- Call options are important financial instruments that allow investors to hedge their portfolios against potential losses and to speculate on the future price of an asset without having to actually purchase the asset.
- The buyer of the call option pays a premium to the seller for the right to buy the asset.
- The strike price is the predetermined price at which the underlying asset can be bought and the expiration date is the date on or before which the option must be exercised.
Conclusion
Call options are an important financial instrument that can be used by investors to hedge their portfolios against potential losses and to speculate on the future price of an asset without having to actually purchase the asset. The buyer of the call option pays a premium to the seller for the right to buy the asset at a predetermined price (the strike price) on or before a specified date (the expiration date). By understanding the basics of call options, investors can make informed decisions about how to best use them to their advantage.
