Katie loves Este Lauder (EL) products and thinks that the price of EL shares will go up. Marissa currently owns EL shares, but thinks that the price will either stay the same or go down in the future. The girls talk, and decide to write up a call option.
An agreement that gives an investor the right, but not the obligation, to buy an asset at a specified price within a specific time period.
Right now, each EL share is priced at 10$. Marissa writes up a call option agreeing to give Katie 100 shares of EL at 12$ per share in a month. The fee that Katie pays for the option (aka premium), is 200$ (the 2$ per stock difference times 100 shares).
If the price of EL shares shoots up to 15$ in a month, Katie can exercise the option and buy Marissa’s 100 shares of EL at only 12$. Since Katie is getting the shares for 3$ less than the actual price, she makes $300 (3$ x 100 shares) minus the initial fee of $200, resulting in a net profit of $100.
If the price of EL shares go down to 8$, Katie will not chose to exercise the option (she won’t buy the 100 shares), and will simply loses the $200 initial fee she paid at the start.
Call options allow individuals to speculate about stocks that they do not own. If you believe a certain company or asset will go up in the future, you might want to consider a call option!