Legal Definitions - call option

A call option is a type of contract that gives the buyer the right, but not the obligation, to buy an asset or service from the seller at a specific price, known as the strike price, on or before a certain date. The buyer pays a premium to the seller for this option. The seller, in turn, benefits from the premium and hopes that the asset's price will not rise above the strike price.

Sarah buys a call option for $1,000 to purchase 100 shares of Banana Inc. at $100 per share. The option expires in one year. If the market value of Banana Inc. rises to $200 per share, Sarah can exercise her option and buy the shares at the lower strike price of $100 per share. She can then sell the shares at the market price of $200 per share, making a profit of $9,000. However, if the market value of Banana Inc. remains below $100 per share, Sarah will not exercise her option, and the seller keeps the premium of $1,000.

This example illustrates how a call option can be used to speculate on the price of an asset. Sarah believes that the price of Banana Inc. will rise, so she buys a call option to benefit from the potential increase in value. The seller, on the other hand, hopes that the price will not rise above the strike price, allowing them to keep the premium without having to sell the asset at a loss.