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When to Buy a Call Option: Strategy and More

Y ou’ll find various long options strategies you can use when you’re trading and want to buy calls. Many options strategies can maximize return and limit risk, so before you dive into trading options, it’s important to gain an understanding of the different strategies available to you.

Key Takeaways:

  • Buying a call option gives you the right (but not obligation) to purchase shares of an underlying asset at a specific price before a specific date.
  • Buying a call is a simple, popular strategy that many investors use when they think the underlying price of a stock will rise.
  • You can also use various other call option strategies such as spreads and butterfly strategies to maximize profits or mitigate risks.

What Does It Mean to Buy a Call Option?

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Buying a call gives you the right, but not the obligation, to buy shares of an underlying stock at a specified price before a specific date. The specified price is known as the strike price, while the end of the specified time frame is known as the expiration date. Typically, you buy 100 shares of the underlying stock with this kind of option.

Any option is a limited time contract. Options have expiration dates by which the contract must either be sold, exercised to buy the stock, or allowed to expire.

Buying a call is a bullish strategy. This is because the call’s value tends to increase as the underlying stock price rises. The gain increasingly reflects the rise in value of that underlying stock as the market price goes above the strike price of the option.

The long call options strategy offers unlimited profit potential while the underlying stock keeps rising. The strategy also limits the financial risk you take, regardless of how low the price of the underlying stock goes. A stock has various different options trading against it at any given time, with several expiration dates and a number of strike prices both above and below its current stock price. To be long on a call option means you purchased calls on a particular stock. The seller of those calls has a short position.

The break-even point when you buy a call is the underlying stock price equal to the strike price, plus the premium you pay for the contract. If volatility increases, this has a positive financial effect on your long call strategy (as with other long options). Decreasing volatility and time decay both have negative effects.

When Should You Use a Call Option Strategy?

Buying a call is one of the most popular strategies option investors use. It’s also one of the simplest strategies out there. When you buy a call, you have the ability to profit from an upward move in an underlying stock’s price. At the same time, you risk less capital than you would if you were to buy the equivalent number of underlying shares outright.

You can buy a call when:

  • You are very bullish on a given stock and want to profit from its rise in price.
  • You want to take advantage of the leverage options offer, along with the limited cash risk.
  • You think the value of a particular stock will rise, but you don’t want to commit all of the capital you would need to buy those shares.

A long call options strategy profits from higher stock prices. Your primary goal when using long options strategies, therefore, will be to pick stocks you think are going to rise in price soon.

You gain leverage from a call option compared to buying underlying shares outright since the lower-priced calls appreciate faster in value in terms of percentage for every point the price of the underlying stock rises. Keep in mind, however, that call options come with a limited lifespan. If the underlying price of the stock doesn’t go above the strike price before the expiration date on the option, the call option ends up expiring worthless.

Example of Using a Long Call Options Strategy

One of the most basic long option strategies is buying call options. Let’s say there’s a stock currently at $50 a share, but you think the price is going to go up to $60 or maybe even higher. You can buy call options with a $50 strike price and a $3 cost.

Remember that each option contract is typically 100 shares of stock. If an option is quoted at $3, it will cost you $300. Likewise, a share price gain of $1 is worth $100.

If that stock goes above $53, the long call option trade is already profitable for you. The option value increases with the stock price. You can sell the options you have when you want to lock in your profit.

Call Spreads

You can utilize both bull call spread strategies or bear call spread strategies:

Bull Call Spreads

You can still make a profit from a smaller gain in price of an underlying stock if you use a long call spread. Using a call spread means you buy call options at one strike price while you sell calls at a higher strike price. Both call options will have the same expiration date.

The benefit of this call option strategy is that you reduce the overall cost of a trade by selling call options at a higher strike price than the call options you buy.

By using a spread, you limit the maximum profit to the difference between your strike prices, minus the cost of the spread. Let’s go with that $50 stock example again. You buy a $50 strike price call for $3 while selling a $55 strike call for $1. That makes your net cost $200, and you get to a profit position as soon as the stock price goes past $52 a share. However, your maximum profit is $300 if the stock goes to $55 or higher.

Bear Call Spreads

This strategy involves buying call options at a high strike price, then selling the same number of call options (again at the same expiration date) at a lower strike price. The calls you sell at the lower strike price always generate more income than the calls you buy at the higher strike price. You get the profit if a share price of underlying stock trades below the strike price of the calls you sell. If the stock ends up trading higher, the calls you buy mitigate that upside risk.

Other Call Option Strategies

You’ll find a variety of strategies for calls. Some other examples of popular strategies include:

Covered Calls

You can go with a covered call when you want to maximize your potential profits on a stock you already have in your portfolio. Covered calls involve selling call options on stock you own already with the goal of earning income from the call option premium while you simultaneously benefit from the stock price rising. Covered calls are a strategy for creating a short-term hedge when you’re still bullish on a stock.

Long Call Butterflies

A long call butterfly may be a good option when you have a specific price target for a stock along with a specific date you want to make a trade. This strategy allows you to make a big bet on a given stock for a relatively low cost.

You can initiate a long call butterfly trade by selling two call options that have a strike price equaling your target price for that stock. Then, you’ll need to buy a call option at a higher strike price.

When you employ this strategy, you want the stock to hit the target price and have all the call options you sell expire worthless at the same time that the one call option you buy generates profits. You get the maximum profits from a long call butterfly if your stock trades exactly to the strike price of the pair of call options you initially sell.

What Is the Potential for Losses With Long Call Option Strategies?

When you use long call strategies, the most money you can use is the cost of establishing a trade. If the price of the stock is below your long call strike price when the options expire, you have a 100% loss. However, if the stock is above your strike price, your long options have an intrinsic value. You can capture that value by selling your options.

Back to the $50 stock price example. If you’re approaching the expiration date of the contract and the stock is at just $51, you can sell the $50 strike call option for at least $1. You’ve just earned $100 in this example.

Y ou can use call option strategies to maximize return and minimize risk when you’re trading options. Whether you buy a call option or go with a more complicated spread or butterfly strategy, these are important strategies to have as an options trader.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

Setting Expectations for Your Investment Return Rate

B efore you dive into stock market investing (or any type of investment), you’ll want to make sure you understand the return rate you might expect from your investment. The investment return rate can help you set reasonable expectations so you can come up with a strategy that helps you meet your investment goals.

Key Takeaways:

  • Any time you’re considering an investment, you’ll want to find a way to measure how that investment might perform. You can look at the investment return rate for any type of investment.
  • You’ll find various metrics that let you determine how profitable an investment is. Rate of return, or RoR, and return on investment, or ROI, are two commonly used methods to assess a return of an investment.
  • What you might consider a ‘good’ investment return rate will depend on the type of investment you’re making as well as the risk you’re taking on to make that investment.
  • The stock market has demonstrated a remarkably consistent return rate when you look at the market over long historical periods.

What Is an Investment Return Rate?

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You can look at the investment return rate to determine how profitable an investment is. This is important basic information, no matter the kind of investment you want to make. Different metrics may be used to calculate how an investment performs. Two common measurements are rate of return and return on investment.

Rate of Return

The rate of return is used to measure an investment’s profit or loss over time. You’ll often see rate of return written as RoR. RoR is the net gain or loss an investment makes over a specified period of time. You express rate of return as a percentage of the initial cost of an investment. Calculating an investment’s RoR determines the percentage change from the beginning of the time period until the end of that period.

You can use the RoR metric to assess a variety of assets, including:

  • Art.
  • Bonds.
  • Real estate.
  • Stocks.

Gains include income you receive from your investment as well as any capital gains you realize when you sell that investment.

RoR is often referred to as the basic growth rate of an investment. While RoR can be used to evaluate the growth of an investment, it does not account for inflation.

Return on Investment

Return on investment, or ROI, is another financial metric. ROI looks at the growth of an investment from beginning to end and measures how well your investment performs in relation to its cost.

ROI is a ratio that compares that gain or loss from an investment to its cost. Although it is technically a ratio, you’ll often see ROI expressed as a percentage. This figure can help you evaluate the potential return of a stand-alone investment. It can also help you compare returns from several different investments.

ROI is used along with other cash flow measures in business analysis to evaluate as well as rank the attractiveness of various investment alternatives. As an approximate measure of an investment’s profitability, ROI can be used to:

  • Measure a stock investment’s profitability.
  • Decide whether you should invest in purchasing a business.
  • Evaluate a real estate transaction’s results.

Because ROI offers a relatively simple calculation, it is used as a universal, standardized measure of profitability. However, ROI does not account for how long you hold an investment. If you want to compare potential investments, a profitability measurement that includes a holding period in the calculation can sometimes be more useful.

What Is a Good Investment Return Rate?

What you might consider a ‘good’ return depends on the type of investment you make. You’ll also want to take inflation out of the picture when you’re considering investments you can make. After all, investors don’t really care about a dollar amount in and of itself. What you’re really interested in is the purchasing power (in other words, how many cars, gadgets, etc., you can buy) that you get out of your investment.

Taking inflation out of the consideration, you’ll see that your return will vary depending on the type of asset. Here are some general guidelines by asset type:

  • Bonds: Bonds offered an average annual return of 5.3% between 1926 and 2018. Investors demand higher returns for riskier bonds.
  • Business ownership: Business ownership includes stocks, and the average annual return for stocks since 1926 has been about 10%. Again, investors usually demand higher returns for riskier businesses; the potential for high returns may cause an investor to agree to take on a bigger risk of failure and loss.
  • Cash: Over time, flat currencies tend to depreciate in value. Holding cash doesn’t offer a viable long-term investment plan; given enough time, cash becomes worthless.
  • Gold: Gold offers a store of value that keeps its purchasing power, but it doesn’t really appreciate over long time periods. Gold can also be extremely volatile from decade to decade, and it frequently moves from big highs to significant lows.
  • Real estate: Real estate return demands usually mirror demands for business ownership and stock (without using debt, that is). Yet again, riskier projects will require higher rates of return.

Setting Proper Investment Return Rate Expectations

No matter your investment, you’ll want to set appropriate expectations before diving into investing. Remember that historical rates of return (which anyway are not guaranteed for the future) didn’t follow smooth, constant upward trajectories. If you were investing during the period you’re looking at from the past, you undoubtedly suffered significant losses, many times for years, before experiencing market rebounds. Historical rates capture returns over the long term.

Let’s take a closer look at what kinds of returns to expect when you’re investing in stocks.

Investment Return Rate for Stocks

The stock market’s average historical annual return over the last century has been about 10%. Year to year, though, returns rarely fit the average.

Remember that the long-term 10% average is the headline rate, and you’ll have to reduce that rate by inflation. You’ll usually lose about 2% to 3% of purchasing power each year due to inflation.

Stock market investing is geared to long-term investments. Generally, your stock market investments should be for money you won’t need for five years or more.

When investors reference that 10% figure, they’re usually talking about the S&P 500 index. The S&P 500 comprises around 500 of the largest publicly traded companies in the United States and is thought of as the benchmark measure when it comes to annual returns.

If you look at the S&P 500 between 1990 and today, you’ll see that there have been both up years and down years. However, those fluctuations have averaged out to a positive return over the period of the past 30 years.

That said, if you pick any single year, you’ll find that returns are often far off from that average. Between 1926 and 2014, there were only six times that returns fell into what would be considered the average 8% to 12% range. Every year returns came in much lower or much higher. You should always expect volatility in the stock market.

Most of the time, returns are positive in a given year. While there’s no guarantee, that 10% average has been fairly steady for a long, long time. That fact offers a way to think about reasonable expectations for stock market investment returns: The returns you can expect depend in large part on what the recent past looked like. The lower the recent returns, the higher future returns will probably be. The opposite is also true, though.

Here are some things to keep in mind:

  • Don’t get TOO enthusiastic when you’re in the midst of good times. Yes, you’re making money in a bull market cycle, but at least part of the future probably won’t be this good.
  • On the other hand, don’t get too down if things look bad. A down market allows you to buy stocks when they’re at attractive valuations while looking forward to higher returns in the future.
  • You’ll get that average return only by buying and holding. Short-term trading usually won’t fall into that average and will instead depend on market conditions at a given time.

Down markets can scare investors. If you’re investing for the long term, though, it’s important not to let down markets drive you away. (On the flip side, if you’re in it for the long haul, you won’t want to chase performance spikes too much either.) The truth is, investing during down markets can help drive the total return on investment of your portfolio. Think of investing like a marathon requiring patience, endurance, and the ability to maintain level emotion. The consistent average investment return rate in the stock market means your patience will usually pay off in the end.

L ooking at investment return rate gives you a way to assess the profitability of an investment and determine how to act. While historical stock market returns are not guaranteed to repeat in the future, the remarkably consistent average should give long-term investors some peace of mind when looking at potential success.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

10 Risky Investments That Could Result in Serious Profit

W hile every investor dreams of doubling their money overnight, the trades that can produce that kind of profit typically carry significant risk. If you can tolerate the possibility of loss, you can potentially collect returns of 200% or higher on your initial investment. These are the 10 risky investments to consider if you’re ready to live in the fast lane:

  • Cryptoassets: These assets, including bitcoin and other forms of cryptocurrency, can increase in value quickly but are largely unregulated.
  • Emerging markets: This type of investment attempts to benefit from a growing national economy, such as the Chinese manufacturing boom of the 2010s.
  • Foreign exchange: Investing in foreign currency, or forex, offers the opportunity to profit from a highly liquid but risky asset.
  • Hedge funds: When you buy into a hedge fund, you purchase shares of a diversified portfolio with active management to optimize profit.
  • High-volatility stocks: With this asset, you try to profit from stocks that have a high beta, which indicates the level of price volatility.
  • Initial public offerings (IPOs): An IPO, or the first public stock issue from a formerly private company, provides the opportunity to get in on the ground floor of potentially astronomical growth.
  • Leveraged exchange-traded funds (ETFs): These assets are popular among day traders who accept the risk of flipping these stocks for profit within the same trading day.
  • Penny stocks: While these low-priced stocks usually aren’t worth the money, trading them in volume can occasionally produce a surprisingly high return.
  • Real estate investment trust (REIT): Shares in a real estate portfolio provide the opportunity to invest in real estate without the time commitment and upfront cost of buying property.
  • Venture capital: An investment in an expanding private startup in exchange for a share of its profits.

What Is a Risky Investment?

Generally, financial experts define a risky investment as one that carries the possibility of both major profit and major loss. Experienced investors can use techniques like technical analysis and fundamental analysis to minimize the risk level associated with a particular asset and increase the likelihood of a successful trade. Feel up to the challenge? Get started with one of these 10 traditionally high-risk, high-reward investments.

Cryptoassets

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This category includes cryptocurrency as well as similar speculative assets such as initial coin offerings and blockchain. Bitcoin is the most widely recognized form of cryptocurrency, which operates outside the established monetary system.

Depending on the specific crypto asset, the associated risks may include high volatility levels, lack of a secondary market, limited security, and lack of liquidity. Potential returns for these assets are unpredictable and can skyrocket or plummet without notice.

Trading in crypto assets requires buying and selling shares from unregulated exchanges, which carries potentially unlimited loss. They lack consumer protections against market manipulations, insider trading, identity theft, and loss of funds. Many cryptocurrencies have a limited market history, which makes it difficult to establish an accurate value.

Emerging Markets

Investing in an expanding national economy can be very profitable when a specific sector, stock, or government bond takes off. However, the risk comes in when the rapid expansion ends prematurely and the asset performs below expectations. For example, this can occur if the country in question has an unstable political environment that shifts without warning, leading to economic consequences. Compounding this problem, American investors often encounter barriers to current, reliable information about emerging markets.

Foreign Exchange

Commonly called forex, foreign exchange is an investment in which you can trade currencies from all over the world. Forex sales and purchases take place on a decentralized market where you negotiate directly with other foreign currency investors. While many foreign currency trades result in significant profit, they also tend to carry high commissions and fees.

The main risk of forex trading comes from its zero-sum structure. With this type of trade, one party receives all the profit and the other shoulders all the loss. In addition, many forms of forex trade on unregulated markets that lack standard investor protections. Aggressive scams are also common in the foreign currency market, so be wary of a deal that sounds too good to be true.

Hedge Funds

This is an actively managed fund in which many investors purchase shares that represent portions of diverse assets and securities. While hedge funds often produce high returns compared to other types of investments, they also incorporate strategies to help decrease the associated risk.

Regardless of diversification and other efforts to mitigate risk, traders must be aware of the possible downsides of hedge funds. These include the inherent risk of short-selling strategies used by these funds, the common hedge fund practice of borrowing money to trade, the risk of the investments held in the hedge fund’s portfolio, the lack of regulatory oversight, and the limited public disclosure and transparency.

High-Volatility Stocks

Investors who want to take advantage of rapidly fluctuating prices often look for stocks with a high beta. This metric describes the impact of market volatility on a specific asset’s volatility.

U.S. News and World Report recommends seeking stocks with a beta of at least 1.5 for this strategy. Examples include:

  • Ameriprise Financial (AMP).
  • Boeing Co. (BA).
  • Citigroup (C).
  • Freeport McMoRan (FCX).
  • Nvidia Corp. (NVDA).
  • SVB Financial Group (SIVB).
  • United Rentals (URI).

If you’re an aggressive investor, consider adding shares of one or more of these firms and other high-beta stocks to your portfolio.

Initial Public Offerings

Commonly referred to as an IPO, an initial public offering is a growing company’s first issue of stock shares to the public market. Because these IPOs often attract a ton of interest and attention, they also have the volatility that fosters short-term returns for those who can brave the risk.

To best use this strategy, avoid high-profile IPOs like Facebook and Snapchat. Instead, look for an undervalued IPO, which can generate both long-term and short-term returns as the market naturally corrects the price. One great example is Twilio Inc., an online communications firm that increased in value by more than 100% in the six months following its IPO.

The main risk associated with an IPO comes from its newness to the market. Although companies must disclose financial information to the federal Securities and Exchange Commission, this due diligence does not guarantee the success of a public stock release.

Leveraged Exchange-Traded Funds (ETFs)

Because ETFs diverse from market performance, long-term returns on these investments can be extremely volatile. However, day traders who strive to purchase and sell an asset in the same business day can often double or even triple their returns by taking advantage of short-term movements.

Penny Stocks

Most investment news sources categorize penny stocks as any stock with a value of less than $1 per share. While this might seem like a deal, few penny stocks actually produce a substantial profit. The penny stock market also suffers from high rates of fraud, limited liquidity, and a lack of transparency. However, if you do serious research and have a high enough trade volume, you can potentially flip a penny stock for an impressive return.

Real Estate Investment Trust (REIT)

A REIT allows you to invest in shares of a residential or commercial real estate portfolio. In exchange for your investment, you receive a share of the profits along with regular dividends and advantageous federal tax treatment.

However, REITs are subject to risk caused by the volatility of the real estate market, economic changes, and fluctuating interest rates. The higher the dividend paid by a REIT, which can be up to 15%, the higher its general risk level.

Venture Capital

W ith this type of investment, you put your money in a private startup seeking expansion capital. While many such fledgling companies fail to deliver on their early promise because of poor marketing, inexperienced management, and other pitfalls, others become extremely valuable household names. When that occurs, early venture capital investors can potentially realize exponential gains.

To reduce your risk when investing in a startup company, look for a firm that has both an outstanding product and the management acumen to actually run a successful global business. Without due diligence, you could lose your initial investment, which will likely be substantial because of the high minimum amount required to buy into most private companies.

These investments aren’t for those of us with limited risk tolerance. However, they have the potential to produce returns that often far exceed those of less risky assets, as long as you don’t mind a bit of uncertainty or want to diversify the more reliable holdings in your portfolio.

Author: Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.