A call option is a contract that gives the buyer the right, but not the obligation, to buy a specified quantity of an underlying asset at a specified price on or before a specified date. The specified price is called the strike price, and the specified date is called the expiration date.
The buyer of a call option pays a premium to the seller of the option. The premium is the maximum amount that the buyer can lose on the option. If the stock price is below the strike price at expiration, the option expires worthless and the buyer loses the premium. If the stock price is above the strike price at expiration, the buyer can exercise the option and buy the stock at the strike price. The buyer can then sell the stock in the market for a profit.
Call options are a type of derivative, which means that their value is derived from the value of another asset. In this case, the value of the call option is derived from the value of the underlying stock.
Call options can be used for a variety of purposes, including:
- Speculation: Investors can buy call options to speculate on the future price of a stock. If the investor believes that the stock price will rise, they can buy call options and profit from the increase in price.
- Hedging: Investors can buy call options to hedge against the risk of a decline in the price of a stock. If the investor owns a stock and they are worried that the price of the stock will decline, they can buy call options to protect themselves from the loss.
- Income generation: Investors can sell call options to generate income. If the investor believes that the stock price will remain stable, they can sell call options and collect the premium.
Call options are a complex financial instrument and it is important to understand the risks involved before trading them.