A call option is a financial contract giving the buyer the right, but not the obligation, to purchase an asset at a specified price within a specified period.
A call option is a type of derivative security that grants its holder the right, without the obligation, to buy an underlying asset—such as stocks, bonds, or commodities—at a predetermined strike price before or on a set expiration date. In finance and wealth management, call options are used for various purposes including speculation, hedging, and income generation. They enable investors to leverage potential upside in an asset with limited initial investment and defined risk (the premium paid). The seller (or writer) of the call option earns income from the premium but takes on the obligation to sell the asset if the option is exercised.
Call options play an influential role in investment strategy, providing a flexible tool to enhance returns or manage risk in family office portfolios. Through purchasing call options, investors can gain exposure to the upside potential of high-conviction stocks while limiting downside to the premium paid, which aligns with risk management objectives. In reporting and tax planning, understanding the nature of option contracts ensures accurate recognition of gains or losses and proper handling of premiums and exercise proceeds for tax purposes. Strategically, call options can be integrated into governance frameworks to diversify income streams or implement tactical overlays, making them valuable in customized portfolio construction for high-net-worth families.
Suppose a family office buys a call option on 100 shares of XYZ Company with a strike price of $50, expiring in 3 months, paying a premium of $3 per share. If before expiration XYZ's stock price rises to $60, the family office can exercise the option to buy at $50, making a profit of $10 per share minus the $3 premium, resulting in a net gain of $7 per share. If the stock price stays below $50, the option will expire worthless, limiting the loss to the premium paid ($300).
Put Option
Whereas a call option gives the right to buy an asset at a specified price, a put option grants the right to sell an asset at a predetermined strike price within a defined timeframe. Together, calls and puts form the basis of option strategies to capitalize on or hedge against market movements.
What happens if I don’t exercise a call option before it expires?
If a call option is not exercised before or on the expiration date, it becomes worthless, and the buyer loses only the premium paid for the option. There is no further obligation or risk.
Can I sell a call option instead of exercising it?
Yes, the buyer of a call option can sell the option contract in the market before expiration if it has value, potentially realizing a profit or limiting losses without buying the underlying asset.
What risks are involved in buying call options?
The primary risk is losing the entire premium paid if the underlying asset's price does not rise above the strike price before expiration. Additionally, options can be complex and may require expertise to manage effectively within a portfolio.
