What Is a Call Option? Long Calls and Short Calls Explained

A call option is a term used in the financial industry to describe a buyer's opportunity to purchase stocks, bonds, and commodities (the underlying assets) at a predetermined price during a fixed period of time. The buyer is not obligated to buy the underlying asset, but they have to decide if they will buy before the call option contract reaches its expiration date. Financial analysts refer to call options as derivatives because their value derives from the value of an underlying asset.

There are a few key elements to consider when learning about how call options work.

1. 1. Call options represent an agreement between buyer and seller. A call option contract outlines an agreement between a person buying call options and a person selling call options. In exchange for the option to buy an underlying security at a set price, the buyer pays the option holder an option premium, or fee, per share.
2. 2. The price of the stock option is called a “strike price.” Whether the stock rises or falls, the call seller guarantees a specific share price—called a “strike price”—up to a specific date.
3. 3. Buying an option does not mean you have to buy shares of the underlying stock. By participating in an options trade, you purchase the right to buy a number of shares at a fixed price, up until a fixed expiration, or expiry date. If you choose to pass on actually purchasing the stock, there is no penalty, but you will not get a refund on the option premium you paid to the seller.
4. 4. The potential profit comes from an increase in market value. To make money on a call option, the price of the underlying asset has to go up between the time you buy your option and the time you purchase the security. For example, let’s say you buy a call option to buy 100 shares of stock at $40 per share with a $2 premium per share. Later within the agreed-upon time frame, if the price goes up to $48 per share, you can still get the stock for your strike price of $40 per share. That means you make $6 on every share you bought (an $8 increase minus the $2 premium per share). In this case, that would be an instant profit of $600.
5. 5. If the price of the underlying asset falls, you lose money. If call options buyers make money when a security’s price rises, it stands to reason they will lose money when the price of a security falls. Let's imagine you bought that same call option of 100 shares at $40 per share. However, due to market volatility, the price of the underlying stock goes down to $31 during the period you hold the call option. This wipes out the value of the option and you forfeit the $200 premium you paid to secure the call option.

Financial analysts use the terms “long call” and “short call” to describe options trading strategies.

• Long call: A long call is a buyer’s bullish bet on the price of a security. When buying a long call, you assume that an underlying stock price will continue to go up well beyond your strike price. You pay for a call option under the assumption that the underlying asset's market price will go up and you will be able to profit from buying at a relatively low price. The maximum loss you can get from a long call is the premium fee you paid to the long call seller.
• Short call: A short call is a seller’s bearish bet on the price of a security. Essentially, the seller bets that the price of the stock will go down from its strike price and the call option will be worthless to the buyer by the expiration date. In this scenario, the seller keeps the premium fee the buyer paid in addition to the stock they declined to buy.

The difference between call options and put options comes down to buying and selling. Each of these types of options is a financial product exchanged between two parties, with one serving as the buyer and one as the seller.

• Call options are the right to buy. Call options give buyers the right to purchase an underlying security at a specified price within a specific period of time.
• Put options are the right to sell. A put option is a derivative investment that gives the option buyer the right to sell a fixed quantity of shares of an underlying security at a set price before the put option contract expires.

All investments and investment strategies entail inherent risks and introduce the potential for financial loss or the depreciation of assets. The information presented in this article is for educational, informational, and referential purposes only. Consult a professional investment advisor before making any financial commitments.

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