Owning equity securities, such as stocks, is one way to participate in the growth of the economy. If the company whose stock you own prospers, you have the right to participate in the company's good fortune, typically through dividends or growth in the company's stock price. You can also profit from a company's growth without actually owning its stock by purchasing a call option.
Call Option Properties
Each call option you own gives you the right, but not the obligation, to purchase 100 shares of a specific stock at a set price for a specified period of time. The set price is referred to as the strike price; the specified stock is referred to as the underlying security; and the date by which you must exercise your option is referred to as the expiration date. If you don't exercise your option before the end of that time period, it will expire, become worthless and cease to exist.
Call Option Etimology
The terminology regarding the term call, as it relates to an option, dates at least as far back as the 14th century. It derives from the Old French word, "clamer," which can be translated as "to call" or "to claim." When you exercise a call option, you call the the underlying stock to yourself -- you claim it as your own. The call option gives you the right to do so.
Buying Call Options
The purchase of call options is one of the simplest and most prevalent types of options transactions. You typically buy a call option because you expect the market price of the underlying stock to increase in value by a certain date. As the stock price increases, the market price of the option will typically increase as well. You don't have to exercise your call option to profit from it. If the call option's price increases above the premium you paid for it, you can sell your call option for a profit.
Selling Call Options
Selling covered call options is a conservative investment strategy that helps your current stock portfolio generate additional income, particularly in stagnant or declining markets. When you sell a call option, you must stand ready to sell the underlying security for the strike price through the expiration date. If the market price of your stock remains below the call option's strike price, the option will expire unexercised and you'll get to keep your stock plus the amount of the premium you received for selling the option. If the call option is exercised, you'll have to sell your stock, but you'll still get the strike price for your stock plus the amount of the premium.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.