Call Option - Explained
What is a Call Option?
Written by J. Mance Gordon
Updated at April 22nd, 2024
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What is a Call Option?
A call option gives a buyer the right to purchase an asset in the future from the seller of the financial option at a pre-established price. The buyer doesnt acquire the obligation but instead the right to buy an underlying asset, which is the basis for a derivative price, at a specified amount during a time frame that isnt longer than a stipulated date. The seller of the call option undertakes the obligation to sell the asset if the financial option is put to use. An investor can buy a call option and expects that the yield will go up. While in the option period, the investor has an upward expectation that the underlying asset will climb in the market for more than what was paid for the option.
How Does a Call Option Work?
If an underlying asset rises in the market, the buyer or owner of a call option benefits from it. The asset has a higher price than the pre-determined price if the call option expires on the expiration date. The buyer of the option can apply the right afforded by the call option and purchase the asset at the agreed price and earns the difference from selling it at the current market price. If the price ends up being less than the pre-established amount, it is known as a "strike price" or "strike," in which the buyer will not use the right of the call option and loses the premium paid for acquiring it. In other words, the benefit has an endless possibility, but the loss is capped at the premium paid. It's the exact opposite for the seller of a call option. The most benefit will be the price for which the option gets sold. The seller will always have that when the asset doesn't go upward in price. However, as the asset value rises, the profit gets diluted, until it comes to a point when it becomes a loss. After that point, the losses are endless. The call option value will always be zero or higher on the due date. The amount of the call option is the maximum of zero or one variable. The variable then is the present value of the asset minus the strike price. "Call = max (0, S - PE)"