Call options are financial contracts that give the owner the right, but not the obligation, to buy an underlying asset at a predetermined price, called the strike price, on or before a specified date, known as the expiration date. Call options are widely used in financial markets for speculation, hedging, and risk management purposes.
Let’s say you are bullish on the stock of a company, and you believe that its price will increase in the future. You can buy a call option on the stock, which gives you the right to buy the stock at a fixed price, even if the stock price goes up beyond the strike price. If your prediction is correct, and the stock price rises above the strike price, you can exercise your option and buy the stock at the strike price, which is lower than the market price. You can then sell the stock at the market price and realize a profit.
For example, suppose you buy a call option on XYZ Company’s stock with a strike price of $50 and an expiration date of three months from now. The premium, or the price of the option, is $5 per share, and the option contract size is 100 shares. If the stock price rises to $60 at the expiration date, you can exercise your option and buy 100 shares of the stock at the strike price of $50 per share. You will then have a profit of $5,000 ($60 – $50 x 100), minus the cost of the option premium, which is $500 ($5 x 100).
However, if the stock price does not rise above the strike price before the expiration date, your option will expire worthless, and you will lose the premium you paid for the option. In this case, your maximum loss is limited to the premium you paid, and you do not have to buy the stock.
Call options are also used for hedging and risk management purposes. For example, a company may own a stock that it wants to protect against a potential decline in its value. The company can buy a put option on the stock, which gives it the right to sell the stock at a fixed price, even if the stock price falls below the strike price. This way, the company can limit its losses in case the stock price drops.
In summary, call options are financial contracts that give the owner the right, but not the obligation, to buy an underlying asset at a predetermined price on or before a specified date. Call options are widely used in financial markets for speculation, hedging, and risk management purposes. As with any investment, there are risks involved, and investors should carefully consider their investment objectives, risk tolerance, and financial situation before buying or selling call options.