A call option is a complex type of financial instrument known as a derivative. No derivatives, including call options, have any inherent value. Rather, they derive their value from the performance of another investment, such as a stock. As leveraged investments, call options can change in value dramatically in a short period of time. If you want to buy or sell options successfully, you'll have to become versed in the vocabulary of options.
Calls & Puts
A typical option can either be a call or a put. A call option gives you the right to buy a stock at a certain price within a specific time frame. A put option, which is the opposite of a call option, gives you the right to sell your stock at a specific price during a certain time period. The term "call" refers to the manner by which you acquire the stock. Owning a call option gives you the right to take or "call" away a stock from another investor.
Notation & Process
Call options carry certain designations to distinguish them from one another and determine their pricing. However, they all share certain characteristics. For example, all calls allow you to buy 100 shares of the corresponding stock, and all options give you until the third Friday of the month to buy the stock. If you buy an IBM Mar 100 call, it gives you the right to buy 100 shares of IBM stock for $100 per share, no later than the third Friday of March. If you choose to buy or call the stock away from another investor, it's known as exercising your option.
If you call stock away by exercising your option, there is no immediate tax consequence. From a tax perspective, calling a stock away is similar to buying a stock. If you sell the stock you acquire by exercising an option, you'll have to pay tax on any gains you earn, same as if you always owned the stock outright. If you sell the option before it expires, or before you exercise it, you'll have to pay taxes on any gain you earn from that trade as well. If your option expires worthless, it's treated as if you sold the option at its expiration value, which is often zero.
In its most basic form, a call option is a way to bet on the value of a stock rising. For example, if you buy an IBM Mar 100 call, you have the right to buy IBM at $100 per share, no matter how high the price goes. If the stock rises to $200 per share by the third Friday or March, you'll have a built-in profit of $100 per share. Calls can also be used to generate extra income. If you sell a call option, you give another investor the right to call stock away from you. In exchange for this right, you'll receive the current price of the option, which can be hundreds or thousands of dollars. Many other more advanced options strategies also exist for experienced investors.
John Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to writing thousands of articles for various online publications, he has published five educational books for young adults.