A European call option is a type of derivative contract that gives the holder (the buyer) the right to buy an underlying asset at a specified price (the strike price) on or before a specified date (the expiration date).
In this case:
- Joe is the buyer (long position) of the European call option. This means Joe pays a premium upfront to Jack in exchange for the right to buy the underlying asset.
- Jack is the seller (short position) of the European call option. This means Jack receives the premium from Joe in exchange for taking on the obligation to sell the underlying asset if Joe exercises the option.
- It is called a "European" call option because Joe can only exercise the option on the expiration date, not before. American-style options allow the buyer to exercise at any time up to and including expiration.
So in summary:
- Joe (the long position) pays Jack (the short position) an upfront premium for the right to buy an underlying asset at a specified strike price on or before the expiration date.
- Joe profits if the underlying asset price rises above the strike price plus the premium paid, while Jack profits by pocketing the initial premium as long as the underlying asset does not exceed the strike price by more than the premium amount.
Hope this explanation helps! Let me know if you have any other questions.