Call Options - InvestMentor

Introduction to Call Options

After getting comfortable with stocks, Delilah, a programmer, and this course’s heroine, seeks to expand her financial toolkit.

She turns to call options, which are financial agreements providing the buyer with the right, but not the obligation, to purchase an underlying asset like a stock at a specified price, known as the strike price, within a set time frame.

This approach allows potential profit from price increases without the need to commit significant capital upfront.

Rights and Obligations of Buyers

The buyer of a call option, or the holder, has the right to purchase the underlying asset at the strike price before the option expires.

This flexibility allows profit from price increases, while the maximum loss is limited to the premium paid for the option.

If the price does not move favorably, the buyer can choose not to exercise the option.

The defined risk and potential for significant upside make call options attractive for investors anticipating price gains.

Delilah Buys a Call Option

Delilah believes that AllTheThings Inc., currently trading at $50 per share, will increase in value.

She buys a call option with a $55 strike price, expiring in three months, paying a $200 premium.

As the buyer, she has the right to purchase 100 shares at $55 each before expiration.

If the stock price rises above $55, she can exercise the option to buy shares below market price or sell the option for a profit.

If the price stays below $55, she can let the option expire, limiting her loss to the $200 premium.

Rights and Obligations of Sellers

The seller of a call option, known as the writer, is obligated to sell the underlying asset at the strike price if the buyer chooses to exercise the option.

In exchange, the seller receives the premium paid by the buyer.

If the asset’s price stays at or below the strike price, the option expires worthless, and the seller keeps the premium.

However, if the price rises above the strike price, the seller could face unlimited losses, since the asset must be sold at a lower price.

Mark Sells a Call Option to Delilah

On the other side of Delilah’s trade is Mark, an investor holding 100 shares of AllTheThings Inc. Mark decides to generate income by selling a call option.

He sells a $55 strike price option, expiring in three months, to Delilah, receiving a $200 premium.

As the seller, Mark must sell his shares at $55 if Delilah exercises the option.

If the stock stays at or below $55, the option expires worthless, and Mark keeps the premium. If it rises above $55, he must sell at $55, missing out on higher market gains.

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