What is a Stock Call Option?

A stock call option is a term associated with a particular stock issue that makes it possible for the holder of the issue to buy the stock at a set price at some point in the future. Typically, this set price is known as a strike price, since the investor may choose to exercise the call once that price is reached or struck in the marketplace. The idea behind the stock call option is that the holder can exercise the call when there is a suspicion that the share price will increase, effectively making it possible to secure the shares at a price lower than the current market price. This in turn makes it possible to earn a return on the investment immediately.

The chief benefit of a stock call option is that the investor holding the option has little to lose and a great deal to gain. Since the price is fixed, the chances for losing money are relatively low. If the stocks do not perform as anticipated, the investor simply chooses to not exercise the option. On the other hand, if the stock should take off and begin to increase substantially in unit price, he or she can exercise the option at that set price and earn a tidy sum immediately. Once the option is exercised and the investors assumes ownership of the shares, he or she may choose to sit on those shares as they continue to increase, or sell the shares after they reach a certain price, effectively locking in a specific return.

There are several different ways to structure a stock call option. One approach is known as the covered call. With this strategy, the investor actually owns shares that can be delivered if the call is exercised. The stock in question is hedged using the premium that is generated by the stock call option. This approach is a common way of generating premium income on stocks that are already in hand.

A second approach to the stock call option is known as an uncovered or naked call. With this option, the investor does not actually own the underlying security used in the option, but has the ability to secure it if the option is actually called by the holder at some point. To a degree, a naked stock call option carries a little more risk, depending on what type of arrangements have been made to secure those shares in the event that a call is issued. Here, the holder still stands to benefit from the arrangement, but the seller may actually lose money on the deal, depending one what he or she has to pay to purchase the shares and then resell them to the holder according to the terms of the call option.