The Basics of a Call Option

What is a Call Option?

A call option is a contractual agreement between the buyer and the seller of the option that gives the right, but not the obligation, for an options holder to buy a specified number of shares of a security at a predefined price(strike price) within a predefined amount of time. Options traders purchase call options with the belief that the security will be above the strike price by the time the option expires. The call option allows buyers to lock in a much lower purchase price if the stock has moved higher.

A call option can be bought, sold, and even shorted. Many traders short calls as a part of a covered call strategy which allows them to insure the downside risk of a stock that they own. A call option sold without owning the underlying security is known as a "naked" call.

You can generally say that the price of a call option moves higher as the stock moves higher and visa versa. The risk of buying a call option is merely the amount of money that was paid for the option. The upside of a call option is unlimited. As with any option, the time premium component of a call option drastically decays in value once the option has 30 days or less till expiration.

When the call option is above the strike price of the option, it is said to be "in the money". Conversely, when the price of the stock is below the strike price of the option, it is said to be "out of the money". Finally, when the stock is trading at the strike price of the option, the option is said to be "at the money".

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