Why purchase a call option

Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products.

List of Partners vendors. Call options are financial contracts that give the option buyer the right, but not the obligation, to buy a stock, bond, commodity , or other asset or instrument at a specified price within a specific time period.

The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price. A call option may be contrasted with a put option, which gives the holder the right to sell the underlying asset at a specified price on or before expiration.

Let's assume the underlying asset is stock. Call options give the holder the right to buy shares of a company at a specific price, known as the strike price , up until a specified date, known as the expiration date. There are many expiration dates and strike prices for traders to choose from. As the value of Apple stock goes up, the price of the option contract goes up, and vice versa.

The call option buyer may hold the contract until the expiration date, at which point they can take delivery of the shares of stock or sell the options contract at any point before the expiration date at the market price of the contract at that time. You pay a fee to purchase a call option, called the premium. It is the price paid for the rights that the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid.

This is the maximum loss. If the underlying asset's current market price is above the strike price at expiry, the profit is the difference in prices, minus the premium. This sum is then multiplied by how many shares the option buyer controls. That's the beauty of options: You're only out the premium if you decide not to play. Call options are often used for three primary purposes: income generation, speculation, and tax management. There are several factors to keep in mind when it comes to selling call options.

Be sure you fully understand an option contract's value and profitability when considering a trade, or else you risk the stock rallying too high. Some investors use call options to generate income through a covered call strategy. This strategy involves owning an underlying stock while at the same time writing a call option, or giving someone else the right to buy your stock.

The investor collects the option premium and hopes the option expires worthless below strike price. This strategy generates additional income for the investor but can also limit profit potential if the underlying stock price rises sharply.

Covered calls work because if the stock rises above the strike price, the option buyer will exercise their right to buy the stock at the lower strike price. This means the option writer doesn't profit on the stock's movement above the strike price. The options writer's maximum profit on the option is the premium received. Options contracts give buyers the opportunity to obtain significant exposure to a stock for a relatively small price. Used in isolation, they can provide significant gains if a stock rises.

For most casual investors, that definition may as well be written in ancient Greek. Then you can either keep the shares which you obtained at a bargain price or sell them for a profit. But what happens if the price of the stock goes down, rather than up?

You let the call option expire and your loss is limited to the cost of the premium. When you hold put options, you want the stock price to drop below the strike price. If it does, the seller of the put will have to buy shares from you at the strike price, which will be higher than the market price.

Because you can force the seller of the option to buy your shares at a price above market value, the put option is like an insurance policy against your shares losing too much value. For every call bought, there is a call sold. So what are the advantages of selling a call? In short, the payoff structure is exactly the reverse for buying a call. Call sellers expect the stock to remain flat or decline, and hope to pocket the premium without any consequences.

The appeal of selling calls is that you receive a cash premium upfront and do not have to lay out anything immediately. Then you wait until the stock reaches expiration. Just ask traders who sold calls on GameStop stock back in January and lost a fortune in days. However, there are a number of safe call-selling strategies, such as the covered call , that could be utilized to help protect the seller.

The other major kind of option is called a put option, and its value increases as the stock price goes down. In this sense, puts act like the opposite of call options, though they have many similar risks and rewards:. For more, see everything you need to know about put options. While options can be risky, traders do have ways to use them sensibly. Of course, if you still want to try for a home run, options also offer you that opportunity, too.

How We Make Money. Editorial disclosure. James Royal. Written by. Bankrate senior reporter James F. Royal, Ph. Edited By Brian Beers. Edited by. Brian Beers. Brian Beers is the senior wealth editor at Bankrate.

He oversees editorial coverage of banking, investing, the economy and all things money. Reviewed By Malik S. Reviewed by. Malik S. Share this page.