Call Option
Key Takeaways
- A call option gives the buyer the right to purchase a stock at the strike price
- Call buyers profit when the stock price rises above the strike price plus the premium paid
- Maximum loss for call buyers is the premium paid
- Selling naked calls carries theoretically unlimited risk
Definition
A call option is a financial contract that gives the buyer the right, but not the obligation, to purchase a specific number of shares (typically 100 per contract) of an underlying stock at a predetermined strike price before or on the expiration date. Call options are purchased when an investor expects the price of the underlying stock to increase.
The call buyer pays a premium to the call seller (writer) for this right. If the stock rises above the strike price plus the premium paid (the breakeven point), the call buyer profits. If the stock stays below the strike price at expiration, the call expires worthless and the buyer loses only the premium paid.
Call options provide leveraged exposure to a stock's upside with defined downside risk. They are one of the two basic types of options, alongside put options.
How It Works
When you buy a call option, you pay a premium and receive the right to buy 100 shares at the strike price. Your profit at expiration = (Stock Price - Strike Price - Premium) × 100. Your maximum loss is the premium paid × 100. Your breakeven is the strike price plus the premium paid.
A call is "in the money" when the stock price is above the strike, "at the money" when equal, and "out of the money" when below. In-the-money calls have intrinsic value; out-of-the-money calls have only time value. As expiration approaches, time value decays (theta decay), working against call buyers.
Selling (writing) a call obligates you to sell shares at the strike price if assigned. Selling a covered call (owning the underlying shares) is a common income strategy. Selling a naked call (without owning shares) carries theoretically unlimited risk if the stock rises dramatically.
Example
An investor buys one Tesla (TSLA) call option with a $260 strike price expiring in 45 days for $12 per share ($1,200 per contract). Breakeven is $272 ($260 + $12). If Tesla rises to $290 at expiration, the call is worth $30 ($290 - $260), and the profit is ($30 - $12) × 100 = $1,800, or a 150% return. If Tesla falls to $240, the call expires worthless and the investor loses the $1,200 premium. Buying 100 shares outright at $260 would have cost $26,000 — the call provided equivalent upside exposure for 4.6% of the capital.
Why It Matters
Call options are fundamental building blocks for options strategies and provide a powerful tool for bullish investors. They allow participation in stock price appreciation with much less capital than buying shares outright, making them attractive for traders with strong directional views.
Calls are also essential components of many options strategies: bull call spreads, long straddles, protective collars, and covered calls. Understanding call options is prerequisite to understanding the broader options market and derivatives pricing theory.
Advantages
- Leveraged upside exposure with limited downside
- Requires much less capital than buying shares outright
- Can be combined in various strategies for different outlooks
- Maximum loss is limited to the premium paid
Limitations
- Premium can be lost entirely if the stock does not rise enough
- Time decay works against call buyers every day
- Leverage amplifies percentage losses as well as gains
- Require correct timing — being right on direction but wrong on timing still loses money
Frequently Asked Questions
Related Terms
Browse more definitions in the financial terms glossary.