Should you buy Call Options

Call Options

The stock markets have created exchanges that trade Stock Options. These stock options come in two types. There are call options, which are the right to buy shares of a stock at a certain price by a certain date. And there are put options, which are the right to sell shares of a stock at a certain price by a certain date.

Call option and put option trading is easier and can be more profitable than most people think. If you have never traded them before, then this website is designed for you. Not only is option trading easy to learn, but trading options should be part of every investor’s strategy.

This introduction to puts and calls provides all the definitions, explanations, examples, and real-life trading tips needed to help the beginner trader learn to trade them successfully! If you keep reading you will learn the basic strategies to help maximize your gains and minimize you losses.

Call Option Definition:

A Call Option is security that gives the owner the right to buy 100 shares of a stock or an index at a certain price by a certain date. That “certain price” is called the strike price, and that “certain date” is called the expiration date. A call option is defined by the following 4 characteristics:

  • There is an underlying stock or index
  • There is an expiration date of the option
  • There is a strike price of the option
  • The option is the right to BUY the underlying stock or index. This contrasts to a put option, which is the right to sell the underlying stock

Call Options Example

Suppose the stock of XYZ company is trading at $40. A call option contract with a strike price of $40 expiring in a month’s time is being priced at $2. You strongly believe that XYZ stock will rise sharply in the coming weeks after their earnings report. So you paid $200 to purchase a single $40 XYZ call option covering 100 shares.

Call Option Payoff Diagram

Say you were spot on and the price of XYZ stock rallies to $50 after the company reported strong earnings and raised its earnings guidance for the next quarter. With this sharp rise in the underlying stock price, your call buying strategy will net you a profit of $800.

 

Why you should not buy Calls

As you can see in the graph the line starts with negative 200 when the price of the option is below 40. Than it rises and it hits zero at $42. Why should you not buy calls? If the stock does not move much and stays under the break even price of $42, you do not make money at all. Instead You will loose the premium you paid for the option.

On the other hand if you sell an call option with a $44 strike price you will receive option premium of 0.50. When the stock goes down, you can keep the premium. When is does not move, you can keep the premium. If it rises a little and stays under $44, you can keep the premium! The stock needs to move at least 10% before you might loose money at expiration.

Conclusion

Most beginning traders start with buying a call. The premium you pay for it is the only risk you take. In theory you can make a unlimited profit. You only start making profit if the stock moves up and reaches above your break even.

With selling a call you will receive option premium. And you will make money 2 out of 3 times. For this reason we like to sell options.

Bewaren