What is a Call Option?

Bullish trader, betting on upside, bullish stock outlook, record highs

A call option is a contract that gains value when the underlying stock rises.  In the most basic sense, then, a call option is a bet that the underlying security will rise in price, enabling you to profit from your investment. However, call options can also be combined with other types of option contracts to construct a number of different bullish, bearish, and directionally neutral trading strategies.

Sticking to the basics for now, a call option that's being used to speculate on higher prices for the underlying stock will be bought to open by a bullish trader. The purchase of this option gives the holder the right -- but not the obligation -- to buy 100 shares of that stock at the strike price, in the event the stock should rise above that strike prior to expiration.

The contract(s) are purchased for an initial upfront cost, known as the "premium." In a straightforward call-buying strategy, the premium paid to acquire a call option is also the maximum potential loss on the trade, should the stock fail to live up to bullish expectations.

A call option is "in the money" when the price of the underlying stock exceeds the strike price of the option. An in-the-money call can be exercised by the holder in order to acquire the shares at a discount to the current market price. Alternately, the contract can be sold to close before it expires, in which case the trader's profit would stem from the gain in the option's premium over the lifetime of the trade.

If an in-the-money call expires without being proactively exercised or sold to close, it may be exercised by the Options Clearing Corporation (OCC). This process is automatic for any options that are in the money by $0.01 or more, unless alternate instructions are provided by the option holder. Traders who do not want their in-the-money calls to be exercised upon expiration should discuss the available choices with their brokers.

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