Definition & Meaning:

This is a type of 'derivative'. A 'call option' (which is also called a 'buying option') is a legal contract with a third party where you agree to have the option to buy (it is your decision if you do or not) from them a specific quantity of a financial asset (e.g. stock in a listed company, currency, a type of bond) at a pre-set price on or before a specific date in the future.

There are a variety of reasons why people would prefer to buy a call option than buy the financial asset directly (e.g. shares in Meta). In times of uncertainty, call options reduce potential losses (referred to as 'hedging') if the price of the financial asset falls from its 'spot/current price'. Also if you don't have the money to purchase a specific quantity of a financial asset (say 10,000 shares), but expect its price to rise in the future, you can get call options for that quantity and might only have to pay say ten percent of what you would have to do if had to actually buy them (more about how people can do that below).

As it is a contract, the entity which creates the call option (called the 'writer') is legally obliged to sell you the financial security at the agreed price (called the 'strike price') if you decide to proceed with the purchase ('take up the option') within the terms of the contract (up to or on the expiration date of the call option). To make it worth their while, the writer/creator of the call option will charge you a fee (called a 'premium'). For call options on stock, you will have to pay a premium (e.g. $1 per share) when you buy the call option and this is non-refundable. With call options, there is a minimum quantity of the financial asset that you would have to buy if you chose to do it. With stocks, it is normally 100 shares in each call option.

In order to make money on a call option at the time the option expires/ends, the price of the financial security needs to be higher than both the strike price and fee combined, if not you would make a loss. For example, if you buy a call option contract for a company's stock at a strike price of $25 and pay a fee of $0.50 for each share, in order to make money you would need the actual/spot share price to be over $25.50.

As said, it is your option to decide whether to buy it or not. So if you don't take up the option, the potential loss would be restricted to the amount of money you originally paid in fees for the call option. Hence the reason why some investors purchase them.

With some call option contracts, no actual trading of the financial asset it refers to occurs when the option expires/ends, but the two parties settle the difference between the spot/current and strike prices in cash. These are called 'cash-settled' options.

The opposite of a call option is called a 'put option'. This is a derivative contract with a third party where you have the option to sell stock at a specific price in the future.

Pronunciation:

Click to hear Call Option

Also Called:

Call, Buying Option.

Related Vocabulary:

Put Options, Deriviatives.

Exercises:

To learn more vocabulary connected to financial trading, you can do our free online exercise on types of financial derivatives.