Call Option

A call option, is a financial contract between two parties, the buyer of the call option has the right to buy an agreed quantity of assets (such as a stock, a currency, or price of gold or crude oil,) from the seller at a certain time for a certain price, but the buyer also has the right not to buy the assets. The seller is obligated to sell the assets to the buyer. No matter the buyer exercises the call option or not, he has to pay a fee (called a premium) for this right, normally 5%~30% of the agreed price.

Example of a call option on a stock

There is a call option for 100 shares of Coca cola stock, with an executive price of $50 per share from 1 Feb 2012 to 1 Sep 2012 in 10% premium. It means that in the period of validity, the buyer of this call option has the right to buy 100 shares of Coca cola stock in the price of $50 per share. Even though the price of Coca cola stock goes up to $80 per share within the period of validity, the buyer can exercise the call option by buying 100 shares of Coca cola from the seller for a total of $5,000 and pays for the premium of $500.
If, however, the Coca cola stock price drops to $40 per share by the time the contract expires, the buyer will not exercise the option (i.e., the buyer will not buy a stock at $50 per share from the seller when he can buy it on the open market at $40 per share). The buyer loses his premium, a total of $500.