by Girl Banker
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An equity call option gives the buyer the right to buy a given number of shares in a given company at a given price on a given date (European-style option) or at any point with a given period of time (American-style option). Only the option buyer can exercise the option.
To buy a call option is called going long a call and selling a call option is going short a call.
Whilst Apple shares are trading at about $80 a share in late 2006 you decide to buy a call option that gives you the right to buy 1,000 shares in Apple Inc. at $200 anytime between 1 Jan 2010 and 31 Dec 2010.
Buying out-of-the-money call options is much cheaper than actually paying the money to buy the shares outright.
The call options are referred to as being out-of-the-money because the strike price, $200, is higher than the current share price of $80. If you buy this contract, you would be expressing the view that you believe in the company so much that you expect the share price to more than double over a four year period. This view would be the basis for buying the right to buy the shares at $200 in four years time, though the current value is only $80.
If at any point in 2010 Apple shares exceeded the option strike price of $200, you could exercise your right to buy the shares at $200 and immediately sell them to lock in a profit. Let’s say each option cost you $1, this means you would pay a premium of $1,000 for this option contract.
In Dec 2010, the Apple share price went over $320.
I created my investment banking blog in 2012 as soon as I resigned from i-banking & published my book, To Become An Investment Banker.
Heather Katsonga-Woodward: On Business, Life & Everything In-Between