Call Option

A call option is an option contract in which the holder (buyer) has the right (but not the obligation) to
buy a specified quantity of a security at a specified price (strike price) within a fixed period of time
(until its expiration).
For the writer (seller) of a call option, it represents an obligation to sell the underlying security at the
strike price if the option is exercised. The call option writer is paid a premium for taking on the risk
associated with the obligation.
For stock options, each contract covers 100
✔ A Simplified Example
Suppose the stock of XYZ company is trading at $40. A call option contract with a strike price of $40
expiring in a month's time is being priced at $2. You strongly believe that XYZ stock will rise sharply
in the coming weeks after their earnings report. So you paid $200 to purchase a single $40 XYZ call
option covering 100 shares.
Say you were spot on and the price of XYZ stock rallies to $50 after the company reported strong
earnings and raised its earnings guidance for the next quarter. With this sharp rise in the underlying
stock price, your call buying strategy will net you a profit of $800.
Let us take a look at how we obtain this figure.
If you were to exercise your call option after the earnings report, you invoke your right to buy 100
shares of XYZ stock at $40 each and can sell them immediately in the open market for $50 a share.
This gives you a profit of $10 per share. As each call option contract covers 100 shares, the total
amount you will receive from the exercise is $1000.
Since you had paid $200 to purchase the call option, your net profit for the entire trade is $800. It is
also interesting to note that in this scenario, the call buying strategy's ROI of 400% is very much
higher than the 25% ROI achieved if you were to purchase the stock itself.
✔ Selling Call Options
Instead of purchasing call options, one can also sell (write) them for a profit. Call option writers, also
known as sellers, sell call options with the hope that they expire worthless so that they can pocket
the premiums. Selling calls, or short call, involves more risk but can also be very profitable when
done properly. One can sell covered calls or naked (uncovered) calls.
✔ Covered Calls
The short call is covered if the call option writer owns the obligated quantity of the underlying
security. The covered call is a popular option strategy that enables the stockowner to generate
additional income from their stock holdings thru periodic selling of call options. See our covered call
strategy article for more details.
✔ Naked (Uncovered) Calls
When the option trader write calls without owning the obligated holding of the underlying security, he
is shorting the calls naked. Naked short selling of calls is a highly risky option strategy and is not
recommended for the novice trader. See our naked call article to learn more about this strategy.
✔ Call Spreads
A call spread is an options strategy in which equal number of call option contracts are bought and
sold simultaneously on the same underlying security but with different strike prices and/or expiration
dates. Call spreads limit the option trader's maximum loss at the expense of capping his potential
profit at the same time.