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Buying Call Options

Buying a call option (�a call�) gives you the right, but not the obligation, to purchase an underlying security at a predetermined price for a certain time period. Call options are available in various strikes and expiration dates. Expiration dates can vary from as short as one month to as long as a year or more. As a call options buyer, you are betting that the underlying security will rise within the time that your option is valid. The maximum risk you take by buying a call option is the amount you paid for the option; in other words, you cannot lose more than the premium you paid for the call. The extent of your potential profit depends on the price increase of the underlying security. As it goes up, the long call becomes more valuable, because you have paid for the right to buy the underlying security at a given strike price. That is why traders buy call options in a rising or bull market.

When trading call options, there are three ways you can exit a trade. You can:

  1. Let the call expire worthless and thereby lose the premium you paid;
  2. Exercise the call at a time when the price of the underlying security trades above the strike price. You can then purchase the stock at the call's strike price and immediately sell it at the current market price, keeping the price difference as your profit.
  3. Sell the call to another trader prior to its expiration. In this case, you make money if the price of the call has risen in value given a rise in the underlying security.

Here is a simple example:

Assume a particular stock currently trades at $40. You buy a call with a strike price of $44 and an expiration date three months into the future. You paid $1 per contract for the right, but not the obligation, to buy 100 shares of the underlying stock for $44.

Now, let us assume the stock goes to $50 within the next three months (i.e., before the option is due to expire). You can now exercise your call option, demanding from the call seller (the option �writer�) that he or she sell the stock to you for $44. Because you can sell the stock immediately at the current market price of $50, you have made a $6 (600%) profit, minus, of course, the cost of the option purchase.

On the other hand, if we assume the stock has declined to $35 by the time the option expires, it would not make sense to exercise the call and buy the stock for $44. In this situation, you would let your option expire worthless and take a loss of $1 per contract. In this case, it is the seller of the call who will realize a profit (of $1 per contract).

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The Information on the Site is provided for information purposes only. The Information is not intended to be and does not constitute financial advice or any other advice. The trading of stocks, futures, commodities, index futures or any other securities has potential rewards, and it also has potential risks involved. Trading may not be suitable for all users of this Website. Past performance is not necessarily an indication of future performance. You absolutely must make your own decisions before acting on any information obtained from this Website.

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