Call Option | Cake Financial

What is a Call Option?

Oct 29th, 2008 | Filed under: Investing Moment, Video

If you’re interested in trading options, you need to understand the difference between the two major types—calls and puts.

First, let’s review how options work. An option is a contract. It gives you the right—but not the obligation—to buy or sell an asset at a specific price before a certain date.

As I mentioned, there are two types of options. One is the call option. It gives you the right to buy an asset at a certain price by a certain date.

That may seem complicated, so let’s look at an example.

Say you think a particular stock, which is currently trading at $100 a share, is going to skyrocket, but you’re short on cash at the moment.

So, you buy a call option on that stock for $1,000. It lets you buy 100 shares of the stock at $100 each anytime within the next three months.

As you predicted, the stock goes through the roof, hitting $1,000 a share. But guess what? You have a contract. Someone has to sell you the stock for $100 a share.

So, you borrow the cash, buy the stock for $100 share, and promptly sell it for $1000 a share. Your profit: $900 per share, or $90,000, minus the cost of the option contract.

So, to sum up, call options are similar to owning stock. You would buy a call option on a stock if you think the stock will increase in value before the option expires.

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