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A Brief Overview of Call Options

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Call Options

Call Options are the Best Known Type of Option

In most cases, investors are talking about call options when they refer to options.

How Call Options Work

• Call options are contracts which give the buyer the right, but not a binding obligation, to buy a block of stock at an agreed upon value known as the strike price.

• The buyer may choose to exercise his option if the price rises above the strike level, or he may elect not to exercise his option if the price stays below the strike value. This is the meaning behind the “right but not the obligation” terminology found in option trading explanations.

• A buyer who uses his right to buy the stock above the strike price essentially earns the difference in value between the strike price and the price at which the stock actually stands at the time that the option is exercised. If a stock trades at $13 and the option strike price is $9, then the option holder can collect the $4 difference, provided he chooses to exercise his option at that time.

• A buyer is never required to exercise the option at any time. The option does come with an expiration date, however, which is statutorily limited to no more than nine months from the day it is created. Rather than take the $4 profit in the example listed above, the buyer may elect to hold out and hope that the option spread increases even further in his favor, albeit at the risk of the spread narrowing back down.

• If the stock price falls below the strike price, the option is considered to be “out of the money” either temporarily or perhaps permanently if it finishes at this level on the expiration date. An out of the money option is never exercised and the buyer ends up losing the entire sum he paid to purchase his call options.

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