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Published online by Cambridge University Press: 05 June 2012
A European call option is the option to buy a share of stock at a given price at some particular time in the future. For example, I might buy a call option to purchase one share of Company X for $40 three months from today. When the three months is up, I check the price of Company X. If, say, it is $35, then my option is worthless, because why would I buy a share for $40 using the option when I could buy it on the open market for $35? But if three months from now, the share price is, say, $45, then I can exercise my option, which means I buy a share for $40, and I can then turn around immediately and sell that share for $45 and make a profit of $5. Thus, today, there is a potential for a profit if I have a call option, and so I should pay something to purchase that option. A significant part of financial mathematics is devoted to the question of what is the fair price I should pay for a call option.
Options originated in the commodities market, where farmers wanted to hedge their risks. Since then many types of options have been developed (options are also known as derivatives), and the amount of money invested in options has for the past several years exceeded the amount of money invested in stocks.
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