Definition:
A call option is a financial contract that gives the holder the right, but not the obligation, to buy a specific asset at a predetermined price (strike price) within a specified period of time. The holder of a call option profits if the asset’s price rises above the strike price.
Key components of a call option:
- Underlying asset: The asset that the option holder has the right to buy.
- Strike price: The predetermined price at which the option holder can buy the underlying asset.
- Expiration date: The date on which the option expires and becomes worthless if not exercised.
- Premium: The price paid to purchase the call option.
How call options work:
- Profit: If the price of the underlying asset rises above the strike price before the expiration date, the option holder can exercise the option and buy the asset at the strike price, then sell it at the higher market price for a profit.
- Loss: If the price of the underlying asset does not rise above the strike price before the expiration date, the option will expire worthless, and the holder will lose the premium paid.
Why are call options used?
- Leverage: Call options allow investors to control a larger position in an asset without having to invest the full purchase price.
- Risk management: Call options can be used to hedge against potential losses in a portfolio.
- Speculation: Call options can be used to speculate on price increases in an underlying asset.
In essence, a call option is a financial contract that gives the holder the right to buy an underlying asset at a predetermined price within a specified period of time, and it’s used for various purposes, including leverage, risk management, and speculation.
