What are call options

Call options are financial contracts that give buyers the right, but not the obligation, to buy an asset at a specific price (strike price) within a set time (expiration date).

The call buyer pays a premium to enter the contract. If the asset’s market price rises above the strike price before expiration, the buyer can profit by exercising the option or selling the contract. If the price stays the same or falls below the strike price, the option can expire worthless and the buyer’s loss is limited to the premium paid.

Each standard call option contract represents 100 shares of the underlying asset, which can be a stock, index, commodity, or other asset. Their core benefit is that they allow holders to benefit from rising prices with limited risk and lower upfront costs compared to buying an asset directly.

The opposite side of a call option is a put option, which gives holders the right to sell rather than buy the asset.

Call options terms

Here are some key terms to know when trading call options:

• Underlying asset: The asset the option is based on
• Strike price: The set price at which you can purchase the asset
• Expiration date: The last day the option can be exercised before it expires
• Premium: The cost to buy the option (quoted per share – one options contract = 100 shares)
• In the money (ITM): The option has value
• Out of the money (OTM): The option has no value
• At the money: The stock price is at the strike price
• Intrinsic value: The value of the option if exercised now (stock price - strike price)
• Time value: Part of the premium based on time left before expiration
• Volatility: How much the price of the underlying asset is expected to move

Long vs. short call options

Call options can be traded in two basic ways: long or short.

Long call option

A long call is when a trader buys a call option, giving them the right to purchase the underlying stock at the strike price before expiration.

The benefits of a long call include unlimited upside if the asset’s price rises, and limited downside with losses capped at the premium paid. There are also risks – the option can expire worthless if the stock doesn’t rise above the option’s strike price, and time decay can reduce the option’s value as the expiration date nears.

Here’s an example of a long call:

Stock X is trading at $200. You buy a call option with a $210 strike price, expiring in one month, for $4 per share ($400 total):

• If the stock rises to $230, the option is worth $20 per share ($230 - $210), or $2,000. When you subtract the $400 premium paid, your profit is $1,600.
• If the stock stays below $210, the option expires worthless and your loss is limited to the $400 premium.

Short call option

A short call is when a trader sells a call option, agreeing to sell the underlying asset at the strike price if the buyer exercises the option. The seller receives a premium upfront.

One of the key benefits of a short call is the ability to earn an income (through the premium) if the stock stays flat or falls. They are also used in covered call strategies, where they hedge risk for sellers who already own a stock.

Uncovered calls, where the seller doesn’t own the stock, can have unlimited downside risk if the stock rises sharply. The seller is also obligated to deliver the shares at the strike price if the call is exercised, even if the stock is valued much higher.

Here’s an example of a short call:

You sell a call option on Stock X, currently trading at $100, with a $110 strike price and $3 premium ($300 total):

• If the stock stays below $110, the option expires worthless and you keep the $300.
• If the stock rises to $130, and you don’t own the stock (uncovered or ‘naked’ call), you’ll be forced to sell at $110 when the stock is worth $130, taking a $20 per share loss that totals $2,000. Subtract the $300 premium and your total loss would be $1,700.

How to calculate call option payoffs

Call option payoff is the profit or loss made from buying or selling a call contract. There are three key variables to consider when calculating this: the strike price, spot price, and premium.

Payoffs for call option buyers

Call option buyers profit when the stock price rises above the strike price. If it doesn’t, they can let the option expire worthless (since there’s no obligation) and their loss is limited to the premium paid.

• Payoff = Spot Price - Strike Price
• Profit = Payoff - Premium

For example, if a call option had a strike price of $100, premium of $4 per share, and spot price at expiration of $110:

• Payoff = $110 - $100 = $10
• Profit = $10 - $4 = $6 per share, or $600 total.

If the stock finishes below $100, the option expires worthless and the buyer loses the $400 premium.

Payoff for call option sellers

Call sellers (or ‘writers’) profit if the stock stays at or below the strike price, because the buyer is unlikely to exercise the option. They get to keep the premium as income.

If the stock rises above the strike price, the seller might be forced to sell their shares at a loss – which can be unlimited if the call is uncovered.

• Payoff = Spot Price - Strike Price
• Profit = Payoff + Premium

For example, a call with a $100 strike, $4 premium, and $98 spot price at expiration would expire worthless. The seller gets to keep the $4 premium, resulting in a total $400 profit.

If the stock jumps to $120, however, the option is likely to be exercised. The seller would be forced to sell at $100 while the stock trades at $120:

• Payoff = $120 - $100 = $20
• Profit = -$20 + $4 = $-16 per share, or -$1,600 total.

Using call options

Using covered calls for income

Covered calls involve owning a stock and selling a call option against it. You collect the premium as income while hoping the stock stays below the strike price so the option expires worthless.

Covered calls are a way to generate income, but they can also limit potential gains if the stock price rises sharply. The maximum profit you’d receive on the option comes from the premium.

Using calls for speculation

If you expect a stock to rise, you can buy a call option instead of buying the shares outright. Your risk would be limited to the premium paid, but you could earn substantial gains if the stock rises.

The benefits of using calls for speculation is that they come with a lower upfront cost than buying the stock, and your losses are capped to the premium paid. However, the risk is that you could lose your entire premium if the option expires out of the money.

Using options for tax management

Some investors use options as a way to manage capital gains taxes. For example, if you own 100 shares of a stock with large unrealised gains, but don’t want to sell it and trigger a taxable event, you can write a covered call or buy a protective put. This allows you to adjust your exposure with the only cost being the option premium.

Call option examples

Example of buying a call option

Imagine a stock is trading at $220. You believe the stock will rise, so you buy a call option with a strike price of $200, at a premium of $4 and an expiry of today. If the stock closes at $220, your option is in the money. Your profit would be ($220 - $200 - $4) x 100 = $1,600.

That’s a return of 400% on your $400 premium.

Now, let’s compare that to simply buying 100 shares of that stock at $200. You would’ve spent $20,000, and your profit at $220 would be $2,000, a total return of 10%.

This example shows how buying options can provide similar exposure with far less capital. If the stock you’d bought had stayed below $200, the option would expire worthless and your loss limited to the $400 premium.

Example of selling a call option

This time you own 100 shares of a stock trading at $216. You want to earn extra income and don’t expect the stock to rise above $230 in the next month. You sell a call option with a strike price of $230 at a premium of $0.74 per share (a total of $74), with one month expiration.

If the stock stays below $230, the option expires worthless. You get to keep the shares and collect $74 in income. If the stock rises above $230, the buyer would exercise the option and you must sell your shares at $230. You lock in a gain of $14 per share (from $216 to $230), plus the $74 premium – but give up any additional gains above $230.

Why would you buy a call option?

Investors buy call options when they believe a stock’s price will go up. That’s because calls provide a lower-cost way to benefit from rising prices compared to buying a stock outright.

Call options also have limited downside, meaning the most you’d lose is the premium paid – no matter how far a stock drops.

Is buying a call bullish or bearish?

Buying a call is a bullish strategy, because you profit if the stock price rises above the strike price. Selling call options, however, is bearish.

What are call and put options?

Call and put options are the two basic types of options contracts:

• Call options give buyers the right to buy an asset at a specific price within a set time
• Put options give buyers the right to sell an asset at a specific price within a set time

Call options are used when a trader expects prices to go up, while puts are used when prices are expected to go down.

Covered options

Covered options are when the seller holds enough of the underlying asset to fulfil the contract if it’s exercised. This helps reduce risk compared to uncovered or ‘naked’ options.

The most common covered strategy is the covered call, where you own a stock and sell a call option on it.

What can happen when you buy options?

What could happen if you write a call?

What could happen if you write a put?