A call option gives a trader the right, but not the obligation, to buy an underlying asset at a predetermined strike price until the call option expires.

To better illustrate the concept, we can break down the components of a call option into the following:

• Underlying Asset: A call option is based on an underlying asset, which can be a stock, commodity, currency, or other financial instrument
• Strike Price: The strike price is the price at which the option holder can buy the underlying asset if they choose to exercise the option
• Expiration Date: Call options have a limited lifespan, which is defined by the expiration date. The option must be exercised (if profitable) or allowed to expire worthless by this date
• Premium: The option buyer pays a premium (a fee) to the option seller (writer) for the right to buy the underlying asset. This premium is the cost of the option

Rights Of The Option Holder

Buying and selling call options gives holders certain rights and privileges that the holders of the underlying asset may not have.

The rights of an option holder include:

• The call option holder has the right to buy the underlying asset at the strike price. If the market price of the asset is higher than the strike price, exercising the option can result in a profit
• If the market price is lower than the strike price at expiration, the option holder is not obligated to exercise and can let the option expire. The maximum loss is limited to the premium paid

Risk & Profit Potential

Options are attractive derivatives due to their limited risk and increased potential for profit. The profitability and risk mitigation of call options can be broken down as follows:

• The risk for the call option holder is limited to the premium paid for the option. This is in contrast to buying the underlying asset itself, where the potential loss is theoretically unlimited
• The potential for profit in a call option trade arises when the market price of the underlying asset rises above the strike price by an amount greater than the premium paid for the option
• The profit is not capped; it can theoretically be unlimited if the asset's price increases significantly

Obligations Of The Option Writer

Writing call options comes with a few requirements and writing naked, or unsecured options, can be exceedingly risky and is generally not advisable:

• The call option writer (seller) has the obligation to sell the underlying asset at the strike price if the option holder decides to exercise the option
• In exchange for taking on this obligation, the option writer receives the premium from the option buyer

To summarize the inherent advantages and disadvantages of call options and using these instruments for trading, we can highlight three crucial points for each side. This can help you weigh up your options and decide whether call options are the best choice for you at any given moment.

Pros

• Profit Potential: Call options offer the potential for significant profits if the market price of the underlying asset rises substantially. The profit is not capped, allowing for unlimited upside potential
• Limited Risk: The maximum loss when buying a call option is limited to the premium paid for the option. This limited risk is advantageous compared to owning the underlying asset, where losses can be substantial
• Leverage: Call options allow traders to control a larger position in the underlying asset for a fraction of the cost. This leverage can amplify returns when the market moves in the desired direction

Cons

• Expiration Date: Call options have a limited lifespan, and if the market price doesn't move in the desired direction before the option expires, the premium paid for the option is lost
• Time Decay: Call options are affected by time decay, which means the value of the option decreases as it approaches expiration. This can erode the option's value, even if the underlying asset's price remains unchanged
• Volatility Risk: High volatility can increase the cost (premium) of call options, making them more expensive. Additionally, rapid price fluctuations can lead to increased uncertainty and potential losses for option buyers

• Call options are derivatives that profit from the increase in the price of an underlying asset
• They give traders the right, but not the obligation, to buy the underlying asset at a specific price, before the options contract expires 
• The price paid of call options is called the premium and is the amount traders put at risk when trading options 
• Writing options can be considerably more risky than selling them, as the underlying asset does not have a theoretical loss limit 
• Call option holders have the right to buy the underlying asset at the strike price, which is a vital threshold that determines the profitability of any options contract