A call option is the right, but not the obligation, to buy an asset at a prespecified price on, or before, a prespecified date in the future. An investor can take a long or a short position in a call option.
Consider a call option with a strike price of $105 and a premium of $3.
This diagram shows the option’s payoff as the underlying price changes for a long call position. If the stock falls below the strike price at expiration, the option expires worthless. The option buyer loses $3 and option seller gains $3. As the stock’s strike price starts increasing above $105, the payoff from the option starts increasing for the buyer. The option will breakeven when the stock price is equal to the strike price plus the option premium ($105 + $3). A call option has unlimited upside potential, but limited downside for the option buyer.
The profit/loss diagram for a long call position is summarized below:
- Maximum profit is unlimited as theoretically the stock price can keep increasing.
- Maximum loss is equal to the option premium paid.
- Breakeven point occurs when the Stock Price = Strike Price + Premium Paid
- The call option holder will exercise the option when the stock price exceeds the strike price.
The following diagram shows the call option payoff from the seller’s perspective.
- The maximum profit is limited to the option premium received.
- Maximum loss is unlimited. The loss increases as the stock price increases.
- Breakeven point occurs when the Stock Price = Strike Price + Premium Received