Call Option

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Call Option

A call option is a financial contract giving the option holder the right, but not the obligation, to buy a specified quantity of an underlying asset (commonly 100 shares per contract) at a predetermined price (the strike) on or before a set expiration date. The buyer pays a fee called the premium. The seller (writer) is obligated to sell the underlying if the buyer exercises.

Key takeaways

  • Buyer’s upside is potentially unlimited if the underlying rises above the strike; buyer’s maximum loss is the premium paid.
  • Seller’s profit is limited to the premium received; seller’s loss can be large or unlimited if uncovered (naked).
  • Main contract terms: underlying asset, strike price, expiration date, and premium.
  • Common uses: income (covered calls), speculation (leverage), and portfolio/tax management.

How call options work

  • Strike price — the price at which the underlying can be bought.
  • Expiration — the last date the option can be exercised.
  • Premium — the price paid to buy the option; the buyer’s maximum loss.
  • At or before expiration the buyer can:
  • Exercise the option and buy the underlying at the strike,
  • Let the option expire worthless (lose the premium), or
  • Sell the option contract in the market for its current value.

If the market price at expiration is below the strike, the option is out of the money and typically expires worthless. If above, it is in the money and has intrinsic value.

Long call vs. short call

  • Long call (buyer): Pays the premium for the right to buy. Profits if the underlying rises above break-even (strike + premium). Risk limited to premium.
  • Short call (seller/writer): Receives the premium and takes on the obligation to sell if exercised.
  • Covered call: seller owns the underlying—losses limited because holding the asset offsets assignment.
  • Naked call: seller does not own the underlying—losses can be unlimited if the underlying rallies sharply.

Payoff and profit calculations

Let S = spot (market) price at expiration, K = strike price, P = premium.

Buyer:
* Payoff = max(S − K, 0)
* Profit = Payoff − P
* Break-even at expiration: S = K + P

Seller:
* Payoff (from buyer’s perspective) = −max(S − K, 0)
* Profit = P − max(S − K, 0)

Example: Buy a call with K = $50, P = $2
* If S = $55 at expiry: payoff = $5, profit = $5 − $2 = $3 per share.
* If S = $48 at expiry: payoff = $0, loss = premium = $2 per share.

Uses of call options

  • Income (covered calls): Own the stock and sell calls to collect premiums. Generates extra income but caps upside above the strike if assigned.
  • Speculation (leverage): Gain exposure to price moves for a fraction of the cost of buying the stock; risk limited to premium but probability of total loss exists.
  • Portfolio/tax management: Adjust economic exposures without selling shares (may help avoid realizing taxable gains). Tax treatment varies by strategy and holding periods.

Examples

  1. Long call profit
  2. Apple trading at $110, strike $100, premium $2, contract = 100 shares.
  3. Payoff per share = $110 − $100 = $10. Profit per share = $10 − $2 = $8.
  4. Profit for one contract = $8 × 100 = $800.

  5. If Apple < $100 at expiry, option expires worthless and the loss is $2 × 100 = $200.

  6. Covered call income

  7. Own 100 shares of Microsoft at $108. Sell a $115 call for $0.37 (premium $37).
  8. If stock ≤ $115 at expiry: keep shares and the $37 premium.
  9. If stock > $115: shares are called away at $115; you gain the share appreciation up to $115 plus the $37 premium, but miss upside above $115.

Simple explanation (Explain Like I’m 5)

A call option is like paying a small reservation fee to lock in the right to buy an item at a fixed price later. If the item’s price goes up, you can buy it at the lower reserved price and profit. If the price doesn’t go up, you don’t have to buy it—you only lose the reservation fee.

Risks and considerations

  • Time decay: Options lose value as expiration approaches (all else equal).
  • Implied volatility: Higher volatility increases option premiums; falling volatility can reduce option prices.
  • Assignment risk: Short-call writers may be assigned before expiration, especially if options are deep in the money.
  • Tax implications: Option gains and losses may be treated as short-term capital gains; specific tax rules vary by strategy and jurisdiction.

Bottom line

Call options are flexible instruments for gaining bullish exposure, generating income, or managing portfolio exposures. Buyers gain leveraged upside with limited downside (premium); sellers earn premium income but may face significant risk if uncovered. Understand strike, premium, expiration, and whether calls you sell are covered before trading.