A financial contract between two parties i.e. the buyer and the seller of this type of option, is referred to as a call option. It is the option to buy shares of stock at a specified time in the future. Usually it is simply labeled a “call”. In call option, the buyer of the option has the right, but it is not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying instrument) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or “writer”) is obligated to sell the same commodity or financial instrument that is so decided by the buyer. For this right the buyer pays a fee that is referred to as a premium.

Buyer and Seller Anticipation

It is the will of the buyer of a call option that the price of the underlying instrument may rise in the future; the seller either anticipates that it will not rise, or he might be willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price.

When the underlying instrument is moving up then the call options are most profitable for the buyer, that makes the price of the underlying instrument closer to the strike price. It is believed by the call buyer that there is a probability that the price of the underlying asset will rise by the exercise date. The risk is limited to the premium only. The buyer can get a very large profit, and it is limited by how high underlying’s spot rises. The option is said to be “in the money” when the price of the underlying instrument surpasses the strike price.

It is not believed by the call writer that there is a possibility that the price of the underlying security can rise. In order to collect the premium, the writer sells the call. For the call writer, the total loss can be very large indeed, and it is only limited by how high the underlying’s spot price rises.

Option Price or Premium

The supplying of a physical or financial asset (the underlying instrument) is not the initial transaction in this context (buying/selling a call option) but rather than that it is the granting of the right to buy the underlying asset, in exchange for a fee that is known as the option price or premium.

Depending on option style, exact specifications may differ. It is allowed by a European call option that the holder can exercise the option (i.e., to buy) only on the option expiration date. Whereas the buyer of an American call option is allowed to exercise at any time during the life of the option.

Other Types of Call option Purchases

Other than stock in a corporation, call options can be purchased on many financial instruments. There are possibilities that options can be purchased on futures on interest rates, for example on commodities like gold or crude oil. You should not confuse a tradable call option with either Incentive stock options or with a warrant. An incentive stock option, is that option that is used to buy stock in a particular company, is a right that is granted by a corporation to a particular person (typically executives) in order to purchase treasury stock. New shares are issued, when an incentive stock option is exercised. On the open market, incentive stock options are not. On the contrary when a call option is exercised, a transfer of the underlying asset is transferred from one owner to another.

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