What is a call option?

A call option, or call, is a contract that grants you the right, but not the obligation, to buy the underlying investment at a specific price, called the strike price, before the option expires. Most options are “American,” meaning you can exercise them at any time up until the expiration date. “European” options are less common and can only be exercised on the expiration date.

Investors buy calls when they expect the price of the underlying stock to increase. The call allows them to buy a specific number of shares, usually 100, at the strike price, regardless of the current market price. (When investors expect the price of a stock to decrease, they can buy a put option, which gives them the right, but not the obligation, to sell a specified number of shares at a predetermined strike price by the option’s expiration date.)

The price of a call is referred to as a premium. This fluctuates depending on a number of factors, including the strike price, the current stock price and the time left until the expiration date. When you buy a call, your risk is limited to the cost of the premium. If the stock declines instead of rising, you can sell the call or let it expire worthless.

Example: “Victor believed shares in his favourite retailer would go up in value when it reported earnings in a few weeks. He had limited cash to invest, so he bought a call option on 100 shares instead, as the premium was lower than the cost of 100 shares of stock. When the stock moved from $25 to $35, he exercised the call, buying 100 shares at $25, then selling them for $35. His profit was $10 a share minus trading commissions and the option premium.”

Read more about options:

• What you need to know about options
  If the recent GameStop drama has piqued your interest, this guide gives you the basics on what options are, how they work, the potential rewards—and significant risks.
• What is a call option? What should retirees care about them?
  Call options are a type of financial contract that investors can buy and sell. Here’s how they can help generate income even when markets are volatile.
• Enhancing your equity income with ETFs
  How to use enhanced income ETFs, as well as dividend and REIT ETFs to provide a steady stream of cash flow for expenses or retirement.
• Questrade vs. Wealthsimple: Which online investing service is right for you?
  We dug into the differences between these seemingly similar online investing services to help you decide which one is for you.

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MoneySense editors and journalists work closely with leading personal finance experts in Canada. Since 1999, our award-winning magazine has helped Canadians navigate money matters.

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