A Call Option is a financial contract which exists between two parties, a buyer and a seller, based on an underlying financial instrument such as a stock. A Call option is one of two different types of financial contracts, both having to do with options trading for stock options. The different between trading stocks and trading options, is that the option has to do with buying and selling the underlying financial instrument at a pre-determined price, so you are essentially buying or selling a fixed price for a stock rather than buying or selling the stock itself.

 

Call options are often simply called a "Call". When someone buys a call option, they are granted the right to buy an agreed upon quantity of an underlying asset from the person selling the all option before the contract expires at a pre-determined time, called the expiration date. The agreed upon quantity of the underlying asset is purchased for a strike price, which is a pre-determined, agreed upon price.

 

Let us look at this in layman terms: A call option is a contract which exists between buyer and seller, allowing the buyer to purchase stock in a specific company for a fixed price. When the expiration date is reached, the call option contract expires and the call option's pre-determined price is no longer valid. For example, if you decide to buy a call option for a stock that has a strike price of $10 with an expiration date for two months later, you can buy that stock at $10 until the call option expires two months from now, no matter what price the stock may actually be at.

 

So for example, if the price of that stock has risen to $15, and the call option agreement is not yet expired, you have the choice to exercise your call option, which will allow you to purchase the exact same stock for the $10 that was originally agreed upon, despite the fact that everyone else is buying it at $15. Now here is where the sweet part comes in: You can immediately turn around and purchase the same stock for $15, which will net you a profit on every share that you purchased. You can also sell the call option contract to other interested buyers to make a $5 profit, because the option contract has gone from $10 to $15 in worth since you purchased it.

 

Call options only tend to cost a small fraction of what the underlying stock costs, but they allow options traders to profit heavily from the exact same moves using the underlying stock as a traditional stock trader would. This is what creates the leverage effect that has made options trading so popular and profitable. A call option contract like the one mentioned above probably cost the buyer around $1 to purchase, when the stock was $10. A traditional stock trader would make a 50% profit if the stock rose to $15, but the options trader would have made a 400% profit!