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Call Option

Definition

A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation, to buy an agreed quantity of a particular commodity or financial instrument from the seller of the option at a certain time for a certain price. The seller is obligated to sell the commodity or financial instrument to the buyer if the buyer so decides. The buyer pays a fee for this right. The term "call" comes from the fact that the owner has the right to "call the stock away" from the seller.

What is a 'Call Option'

A call option is an agreement that gives an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period.

Explaining 'Call Option'

Call options are typically used by investors for three primary purposes. These are tax management, income generation and speculation.

How Options Work

An options contract gives the holder the right to buy 100 shares of the underlying security at a specific price, known as the strike price, up until a specified date, known as the expiration date. For example, a single call option contract may give a holder the right to buy 100 shares of Apple stock at a price of $100 until Dec. 31, 2017. As the value of Apple stock goes up, the price of the options contract goes up, and vice versa. Options contract holders can hold the contract until the expiration date, at which point they can take delivery of the 100 shares of stock or sell the options contract at any point before the expiration date at the market price of the contract at the time.

Options Used for Tax Management

Investors sometimes use options as a means of changing the allocation of their portfolios without actually buying or selling the underlying security. For example, an investor may own 100 shares of Apple stock and be sitting on a large unrealized capital gain. Not wanting to trigger a taxable event, shareholders may use options to reduce the exposure to the underlying security without actually selling it. The only cost to the shareholder for engaging in this strategy is the cost of the options contract itself.

Options Used for Income Generation

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 selling 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. This strategy generates additional income for the investor but can also limit profit potential if the underlying stock price rises sharply.

Options Used for Speculation

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, but can also lead to 100% losses if the call option purchased expires worthless because the underlying stock price went down. Options contracts should be considered very risky if used for speculative purposes because of the high degree of leverage involved.


Further Reading


Tests of the Black-Scholes and Cox call option valuation models
www.jstor.org [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

An empirical examination of the Black-Scholes call option pricing modelAn empirical examination of the Black-Scholes call option pricing model
www.jstor.org [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

Anticipated information releases reflected in call option pricesAnticipated information releases reflected in call option prices
www.sciencedirect.com [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

Determinants of the call option on corporate bondsDeterminants of the call option on corporate bonds
www.sciencedirect.com [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

Real-options valuation for a biotechnology companyReal-options valuation for a biotechnology company
www.tandfonline.com [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

Call option pricing when the exercise price is uncertain, and the valuation of index bondsCall option pricing when the exercise price is uncertain, and the valuation of index bonds
www.jstor.org [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

The guaranteed maximum price contract as call optionThe guaranteed maximum price contract as call option
www.tandfonline.com [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …

Transaction data tests of S&P 100 call option pricingTransaction data tests of S&P 100 call option pricing
www.cambridge.org [PDF]
THE JOURNAL OF FINANCE * VOL XXXV, NO … diffusion processes; moreover, we find that the Cox valuation model fits market prices of call options significantly better … Thus, our results have important implica- tions for empirical analysis of call option data and may very- well have …



Q&A About Call Option


What does it mean when you say that someone has the right, but not the obligation, to buy something?

The person who has this right can choose whether or not they want to exercise their rights. If they do decide to exercise their rights, then they are obligated to buy whatever it is that they have been given permission to purchase.

How does one speculate with options?

By buying puts and calls on stocks they don't own.

How does time affect options prices?

The longer until expiration, then generally speaking, the higher an options price will be. This is because there is more time for things like dividends and volatility changes in order for them to impact on value of an option contract. However if there are significant dividends coming up soon which might change value significantly before expiration date then this would cause a drop in current values as investors try and get out before these dividends come into effect. Also if there are no major changes expected in volatility or other factors affecting value over time then this would also cause a drop in current values as investors wait for any upcoming events which could change things so that they can take advantage of them rather than buying now with no chance of making money from those events happening later on (unless you have already bought insurance against these events). In general though we see that as time goes by without any major changes expected in value due to factors such as volatility or dividend payments then we expect prices for options contracts with longer times until expiry will tend towards being lower than those with shorter times until expiry (except where significant dividends are present) since there's less chance that anything dramatic will happen before expiry date compared with after

What is a call option?

A call option is an agreement that gives the holder the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period.

How does one use options for tax management?

By selling covered calls on stocks they already own.

What are three primary purposes of using options?

Tax management, income generation and speculation.

How does volatility affect options prices?

The more volatile an underlying instrument is, then the higher the price of an option will be.

How does one use options for income generation?

By writing covered calls on stocks they don't own.

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