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"Selling" in this context is not the supplying of a physical or financial asset (the underlying instrument), rather it is the granting of the right to buy the underlying, against a fee - the option price or premium.

Exact specifications may differ depending on option style. A european call option allows the holder to exercise, i.e. to buy, on the delivery date only. An american call option allows exercise at any time during the life of the option.

The stock option, the option to buy stock in a particular company, is the most widely-known call. However options are traded on many other financial instruments - such as interest rates (see interest rate cap) - as well as on physical assets such as gold or crude oil.

Example of a call option on a stock

• I buy a call on Microsoft Corp. strike price $50, exercise June 1 2005.
• If the share price is actually $60 on that day (the spot price) then I would exercise my option (i.e. buy the share from the counter-party). I could then sell it in the open marketIn economics, the Open Market is the term used to refer to the environment in which bonds are bought and sold. To intervene in the " business cycle", a central bank may choose to go into the open market and buy or sell government bonds, which is known as for $60, i.e. the option would be worth $10; my profit would be $10 minus the fee I paid for the option.
• If however the share price is only $40 then I would not exercise the option (if I really wanted to own such a share, I could buy it in the open market for $40, why waste $50 on it). The option would expire worthless.
• Thus, in any future state of the world, I am certain not to lose money on the underlying by owning the option; my loss is limited to the fee I have paid.

From the above, it is clear that a call option has positive monetary value when the underlying instrument has a spot priceThe spot price of a commodity is the price that is quoted for transaction immeadiately. This is contrasted with a forward price, which is the price at which a commodity may be transacted (bought/sold) at a future date. Stock market. (S) above the strike price (K). Since the option will not be exercised unless it is " in-the-money", the payoff for a call option is

Max[ (S-K) ; 0 ] or formally,

where

Prior to exercise, the option value, and therefore price, varies with the underlying price and with time. The call price must reflect the "likelihood" or chance of the option "finishing in-the-money". The price should thus be higher with more time to expiry, and with a more volatileVolatility is the standard deviation of the change in value of a financial instrument with a specific time horizon. It is often used to quantify the risk of the instrument over that time period. Volatility is typically expressed in annualized terms, and i underlying instrument. The science of determining this value is the central tenet of financial mathematicsFinancial mathematics is the branch of applied mathematics concerned with the financial markets. The subject naturally has a close relationship with the discipline of financial economics, however the subject is narrower in scope and more abstract. A centr. The most common method is to use the Black-ScholesThe Black-Scholes model often simply called Black-Scholes is a model of the varying price over time of financial instruments, and in particular stocks. The Black-Scholes formula is a mathematical formula for the theoretical value of European put and call formula. Whatever the formula used, the buyer and seller must agree this value initially.

Related: MoneynessIn finance, moneyness is a measure of the degree to which a derivative security is likely to have positive monetary value at its expiration. An option is at-the-money if the strike price, i. the price the option holder must pay to exercise the option, is, Option time valueConceptually, the value of an option consists of two components, its intrinsic value and its time value . Time value is simply the difference between option value and intrinsic value. Intrinsic value is the difference between the exercise price of the opt, Put option, Put-call parity

See also: Derivatives markets, Derivative security, Financial economics, Futures, Financial instruments, Finance

Options: Stock option, Warrants, Foreign exchange option , Interest rate options, Bond options , Options on futures, Swaption, Interest rate cap, Interest rate floor, Exotic interest rate option, Credit default option, binary option, real option