What Is A Call Option?

A stock option is a contract between two parties giving one person the right to buy stock and the other person the obligation to sell stock. There are two kinds: calls and puts.

A call option gives the buyer of the option the right to buy stock at a certain price ("strike price") on or before a certain date ("expiration date"). Likewise, the seller of a call option is obligated to sell stock at a certain price by a certain date if the buyer chooses to exercise his right. In exchange for this obligation, the buyer pays the seller "option premium".

For example, a "February 35 call option on XYZ stock" gives the buyer of the call option the right to pay $35/share for 100 shares of XYZ stock any time between now and the 3rd Friday in February (monthly options always expire on the 3rd Friday of the month). If that buyer decides to exercise his right to buy the stock at $35/share then the person who sold him the call option is obligated to sell 100 shares of XYZ stock to him at $35/share.

The buyer and seller agree in advance on (1) the stock involved (called the "underlying security" or "underlying"), (2) the duration of the option ("expiration date"), (3) the exercise price ("strike price"), and (4) the price of the option. Like stocks, there are many investors buying and selling options every day and each has a bid and ask price quoted by the exchanges.

What Can You Do With A Call Option?

Make money. Or lose it.

If you feel a stock is going to go up in a short period of time, you can buy a call option. It's cheaper than buying the stock, but you have to be right on the timing of the stock's move. If the stock goes up enough before the option expires then you could do quite well. But if it stays flat to expiration and then moves up after the option expires you will lose.

Selling call options, unlike buying call options, is a great way to make money. Consider that 75% of all options held to maturity expire worthless. Odds are in your favor if you're the seller, not the buyer. But you have to protect yourself by owning the underlying stock at the time you sell the call option. This is called a "covered call" and the rest of this tutorial will explain how to make money with covered calls.

Now You Know What A Call Option Is

So there you have it, a simple to understand call option definition and example. The next time someone asks you "What is a call option?" you'll know exactly how to answer. (One good answer is "A conservative way to earn recurring monthly income." Read more to see how...)

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