An option is a financial instrument whose value is derived from an underlying asset. Purchasers of call options gain the right to buy the underlying asset, or stock, at a predetermined strike price on or by a predetermined expiration date.
The market price of the call option is called the premium. It is the price paid for the rights provided by the call option. If at expiration, the underlying asset is below the strike price, the call buyer loses the premium paid.
Do Investors Have the Right to Buy Call Options or an Obligation?
The buyer of an option is not obligated to buy the stock at the strike price. They just have a right to do so, if chosen.
For example, let's say that an investor buys one XYZ call option with a strike price of $10, expiring next week for a dollar. If the stock trades at $10.05 the day after the call option is bought, the investor has the right to buy the stock for $10 but is not forced to buy the stock.
What About the Writer of the Call Option?
On the other hand, a writer, or seller, of a call option is obligated to sell the underlying asset at a predetermined price, known as the strike price, if the call option that the investor sold is exercised. The writer of a call option is paid to take on the risk that is associated with being obligated to deliver shares.
For example, an investor sells a call option with a strike price of $15, expiring next week, for a dollar, and the stock is currently trading for $13. In this scenario, the writer collects a premium of $100 because an equity option contains 100 options per contract.
This indicates that the investor is bearish on the stock and thinks the price of the stock will decrease. The investor hopes that the call will expire worthless.
However, the day before the option expires, let's say that the company publishes news that it's going to acquire another company, and the stock price increases to $20. As a result, many holders of the call options exercise their options to buy. This means that the seller of the call option is obligated to deliver 100 shares of the company's stock at $15 per share.