A call gives
- the owner (buyer) of the call
- the right (not the obligation)
- to buy the underlying (a given stock)
- at a given price (strike)
- before a given date (expiration date)
- In exchange, the owner of the call pays a premium to the seller.
As a buyer, you only have rights. It means that you decide what happens. The only risk you take is the option premium that you pay to buy the option contract. You can never loose more than this amount. It is your call (pun intended) to exercise your right and actually buy the stock at the strike price. You can do this anytime before the expiration date (american style options only – this is most options except on indexes like AEX, SPX,…)
You buy a call option on stock ABC (the underlying) for a strike of 60€. Imagine that this trades for 0,5. The option expires on May 19.
This means that you have the right to buy ABC at a price of 60€ between now and May 19. This will be on next to the premium you paid. So, you will be paying in the end 60,5 for the stock ABC. (and the trading costs off course)
Why buy a call option?
If you think that the underlying will go up, then you can buy a call option. With a limited investment – the premium – you could get great returns. Imagine stock ABC, worth now 50. You buy an option that expires one month from now at a strike of 55. You pay 1 for this.
If at the end of the month the stock is worth 60, then you just turned your 1 into 5.
You paid 1 for the option
You exercise your right to buy the stock for 55. As the market price now is 60, you could sell it and make an instant 5 of profit. You just multiplied your investment 5 times. Keep in mind the trading costs
here is the caveat. The stock needs to be above 55 one month from now. If not, the option is worth 0€ to you. Imagine the stock is at 54,5 one month from now and then jumps to 60 a week later. You lost your premium. You have no gain.
After the expiration date, you no longer have the right to buy the stock. You have now zero rights.