Call options are financial contracts that give the buyer the right, but not the obligation, to buy 100 shares of an underlying stock at a predetermined price (the strike price) by a specific date (the expiration date). Think of a call option like a reservation – just as you might come up with a deposit to reserve something at a specific price, buying a call lets you reserve the right to purchase shares at today’s agreed price, even if the stock rises significantly. Call options are essential tools for speculation, income generation, and portfolio management, forming the foundation of many options strategies.
Basic Call Option Mechanics
Every call option contract represents 100 shares and has several key components:
Strike Price: The price at which you can buy (or be forced to sell) the shares Expiration Date: The last day the option can be exercised Premium: The price paid for the option contract Underlying: The stock or ETF the option is based on
Call options have a direct relationship with stock price – they increase in value as the stock price rises and decrease in value as the stock price falls.
The Two Sides of Call Options
Buying Calls (Long Calls)
When you buy a call, you pay a premium for the right to buy shares at the strike price. Buyers typically:
- Believe the stock price will rise significantly (bullish speculation)
- Want to control shares with less capital than buying stock
- Seek unlimited upside potential with limited risk
Maximum Loss: The premium paid Maximum Gain: Unlimited (stock can theoretically rise infinitely) Breakeven: Strike price plus premium paid
Selling Calls (Short Calls)
When you sell a call, you collect a premium but accept the obligation to sell shares at the strike price if assigned. Sellers typically:
- Want to generate income from stocks they own (covered calls)
- Believe the stock price will stay flat or fall
- Are willing to sell their shares at the strike price
Maximum Loss: Unlimited if uncovered (naked) Maximum Gain: The premium collected Breakeven: Strike price plus premium received
Call Option Moneyness
In-the-Money (ITM): Strike price is below the current stock price
- Example: $50 strike call when stock is at $55
- Has intrinsic value of $5 ($55 – $50)
At-the-Money (ATM): Strike price equals the current stock price
- Example: $50 strike call when stock is at $50
- Has no intrinsic value, only time value
Out-of-the-Money (OTM): Strike price is above the current stock price
- Example: $50 strike call when stock is at $45
- Has no intrinsic value, only time value
Real-World Call Examples
Example 1: Buying a Call for Speculation
XYZ is trading at $50, you buy a 30-day $52 call for $1.00:
- Cost: $100 (100 × $1.00)
- Breakeven: $53 ($52 strike + $1 premium)
- If stock rises to $57: Profit = $400 (($57-$52-$1) × 100)
- If stock stays below $52: Lose the $100 premium
Example 2: Selling a Covered Call for Income
You own 100 shares of XYZ at $48 cost basis, currently at $50. You sell a weekly $52 call for $0.40:
- Income: $40 (100 × $0.40)
- ROR on strike: 0.77% for one week ($40/$5,200)
- Annualized ROR: 40.1%
- If stock stays below $52: Keep shares and the $40
- If stock rises to $54: Sell shares at $52, total profit = $440 (($52-$48) × 100 + $40)
Call Option Pricing Factors
Stock Price: As stock price rises, call values increase Strike Price: Lower strikes are more valuable for calls Time to Expiration: More time = higher premium Volatility: Higher volatility = higher premium Interest Rates: Higher rates slightly increase call values Dividends: Expected dividends decrease call values
Time Decay (Theta)
Call options lose value over time, with decay accelerating as expiration approaches:
- Far from expiration: Slow, steady decay
- 45-21 days out: Decay accelerates
- Final week: Rapid decay, especially for OTM calls
Call sellers benefit from time decay, while call buyers fight against it.
Implied Volatility (IV)
IV represents the market’s expectation of future price movement:
- High IV = expensive options (higher premiums)
- Low IV = cheap options (lower premiums)
- IV often spikes before earnings or major events
- Call sellers prefer high IV (collect more premium)
- Call buyers prefer low IV (pay less premium)
Common Call Strategies
Covered Calls: Sell calls against shares you own for income Long Calls: Buy calls for bullish speculation Call Spreads: Buy and sell calls at different strikes to define risk/reward Naked Calls: Sell calls without owning shares (requires margin, very risky)
Assignment and Exercise
For Call Sellers:
- Assignment means you must sell 100 shares at the strike price
- Usually happens at expiration if ITM
- Early assignment more common with calls, especially before ex-dividend dates
For Call Buyers:
- You can exercise anytime before expiration (American-style)
- Usually only beneficial if deep ITM near expiration
- Often better to sell the call than exercise (capture remaining time value)
Call Option Greeks
Delta: Rate of price change relative to stock movement
- Highest for ATM options near expiration
Theta: Time decay rate
- Negative for call buyers, positive for call sellers
Vega: Sensitivity to implied volatility changes
- Positive for both call buyers and sellers
Rho: Sensitivity to interest rate changes
- Positive for calls but usually minimal impact
Risk Management with Calls
Position Sizing: Never risk more than you can afford to lose Diversification: Don’t concentrate all capital in one underlying Exit Planning: Set profit targets and stop losses before entering Rolling: Extend duration or adjust strikes to manage positions
Covered Calls vs Naked Calls
Covered Calls (own the shares):
- Limited risk (already own shares)
- Popular income strategy
- Maximum loss = stock going to zero minus premium
Naked Calls (don’t own shares):
- Unlimited risk (stock can rise infinitely)
- Requires margin account
- Generally not recommended for beginners
Tax Considerations
Call Premiums:
- Sellers: Taxed as short-term capital gains when expired/closed
- Buyers: Premium is added to stock basis if exercised, capital loss if expired
Covered Calls: Can affect holding period of underlying shares Qualified Covered Calls: Special rules for maintaining long-term capital gains treatment Wash Sales: Be aware when trading calls and stock on same underlying
Always consult a tax professional for your specific situation.