What is a call option, is a question new investors often ask. In financial trading you often hear the phrase Call Option. This phrase refers to a contract between traders. In an Option Call contract the Seller holds a quantity of an Underlying Financial Instrument. The Instrument can be any of a number of financial entities, such as stock. The option refers to a right given to the Buyer from the Seller by which the Buyer may acquire a stated amount of the Instrument from the Seller at a stated price within a stated period of time. The Buyer pays the Seller a non-refundable fee, usually a percentage of the current selling price, for the right.

Option call contracts come in two flavors; American or European. Under the terms of American option calls, the Buyer may exercise the option at any time prior to the expiration date of the option call contract. Under the terms of European call options the Buyer may only exercise the option call at the end of the designated time period under the terms of the contract.

If this sounds confusing, it is because understanding what is an option call is easier by example. As an example, let us assume pork bellies are selling at a spot price of ten dollars per unit. A Buyer wants to purchase an option to buy pork bellies at the spot price plus one dollar, or ten percent, in 30 days. Let us assume that a Seller owns a thousand units of pork bellies and wants to hedge their bet against a decline in the spot price by selling an option to the Buyer to buy 100 pork belly units at the spot price plus ten percent per unit. This is the strike price. The cost to the Buyer for the option is set at five percent of the spot price, or, in this example, 50 cents times 100.

In this example the cost of the call option to the buyer is 50 dollars. For the Buyer to be in the money, the Instrument, that is, pork bellies, must go up by more than five percent at some point during the term of the contract and the Buyer must then exercise their option. This assumes we are discussing an American call option. As previously stated, if it is a European call option, the Buyer is limited to exercising the option at the conclusion of the contract period.

In this example it is clear that the Buyer believes, or at least hopes, that the spot price for pork bellies will increase by at least five percent over the next 30 days. If it does not, the Buyer will write off their 50 dollar investment, leaving the Seller with a 50 dollar profit on the transaction.

What is a call option limited to, you ask. The answer is that essentially any financial instrument that can be traded may be traded by means of call options. This includes funds, stocks, bonds, debt instruments and commodity futures.

One area of confusion concerning what is a call option is executive bonuses where executives receive stock options as part of their pay package. This type of option is termed an incentive option. The stock the executive has an option buy is new stock that is issued specifically for the executive. It is not stock that is currently trading on the market.
Options investing involves risk and is not suitable for all investors. It is possible for an options investor to lose the entire amount committed to options in a relatively short period of time.

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