Buying Call Options
Buying a call option (ï¿½a callï¿½) 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:
- Let the call expire worthless and thereby lose the
premium you paid;
- 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
- 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 ï¿½writerï¿½) 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
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