A call option is a type of financial instrument known as a derivative. It is basically an agreement between two parties to exchange ownership of a stock at an agreed upon price within a certain time period. The exchange of the stock is optional and the owner of the call option decides whether it takes place.

The agreed upon price of the exchange is called the strike price. The date on which the agreement expires is the expiry date of the call option. The amount of money required to purchase this call option is called the premium. If the exchange takes place, then one is said to have exercised the call option.

Call option premiums are always quoted per stock, but sold in lots of 100 shares minimum. Call options are always an agreement about being able to purchase the stock at the agreed upon price. Call options come in both European style and American style.

European style call options are sold on European exchanges, while American style call options are sold in North American exchanges. The difference is quite simple. European options can only be exercised on the expiry day, while American style options can be exercised at any time during the life of the call option.

Call options are frequently described by the relationship of the strike price to the stock price. A call option for which the strike price is equal to the stock price is said to be an "at the money" call option. If the strike price is above the stock price, the call option is said to be an "out of the money" call option. Finally, if the strike price is less than the stock price, the call option is said to be "in the money".

There are two investment styles when investing in call options. Conservative investors sell an "out of the money" call option on a stock that is part of their portfolio to increase the overall return on their portfolio. The intention is that the stock price will not increase at such a rate that it becomes equal to or greater than the strike price. In this case, the investor gets to keep the premium and the stock, and the call option expires worthless. The process will then be repeated.

The speculative call option investor will purchase "at the money" call options without owning the underlying stock. The expectation is that the price of the call option will increase as the price of the stock increases. Typically, if the stock price increases by one US dollar (USD), the price of the call option will also increase by one USD. However, since the call option may cost as little as one tenth of the stock, the rate of return on the investment is much higher with the call option than it would be if the stock were purchased.

For example, if the stock cost 10 USD, then the call option for this stock for a 10 USD strike price could cost 1 USD. If the stock were to increase in price to 11 USD, the profit with the stock purchase is 1 USD and equal to a 10% return; however, the call option profit is also 1 USD, and since only 1 USD was invested, a 100% return is realized. However, if the price were to drop to 9.50 USD, the call option would become worthless and the entire 1 USD investment would be lost, while only 0.50 USD would be lost with the stock purchase. With the leverage, a call option provides that gains are magnified, but losses are as well. The stock owner would also receive any dividends paid out, while the owner of a call option would not.