Ever look at a high-priced stock and want to buy, but couldn’t do it because it was too expensive? Call options let you get around that problem. Essentially, a call option is a tool you can use to buy stocks at a fixed price and lowers your risk.
But before you learn how to trade call options, you must understand how call options work. Here’s a brief tutorial on how call options work and how to trade call options when you’re bullish on a stock:
The Call Option
Call options provide you with exposure to a stock or ETF and the ability to profit from its price movements in a cost-efficient manner. For example, options allow you to trade directionally, as well as make money on volatile moves. Many have traders come out of the woodwork and want to learn how to trade call options.
If you purchase and hold a call option, you have the right to buy 100 shares of the stock at a specified price, or the strike price. That right only lasts until the option’s specific expiration date.
You’re not obligated to exercise your call option. If the call option expires one penny above the specified strike price, you will automatically be exercised. Consequently, you would be long on the stock at the strike price. Keep in mind, there are a lot of factors affecting the price of a call option, including its implied volatility, time to expiration, the underlying stock’s price, interest rates, and dividends.
Here’s an example to give you a better idea of how call options work:
Check out the sample PnL graph of a call option at expiration:
Generally, call options tend to be cheaper than buying shares.
Let’s take a look at an example. Assume you purchased one call option on Facebook (FB), expiring one month from today, for $5. Equity options generally have a multiplier of 100, and therefore, your total investment would be worth $500. Assume the stock is currently trading at $150, and based on your analysis, you believe the stock could go to $160. Therefore, your strike price would be at $160, and if the stock rises to $160 before the call option expires, your option would be considered “in the money.“ If the stock rises to $160 before the option expires, the option would gain in value, and all else would be equal.
If the stock price does not rise to $160 and you hold it to the expiration date, your maximum loss would be just what you invested into the call option, or $500.
Sometimes it’s more beneficial to use call options to express your opinion on a specific stock or an index.
Since options give you leverage, you can have outsized gains. Adding call options to your trading plan helps you take advantage of rises in stocks after their costs dip down to your target price.
Buying call options intelligently, with enough forethought and planning, can be a powerful way of boosting your portfolio.
Final Thoughts on Call Options
Call options are difficult to understand but are worth trading because of the buying power they give you. Call options are a cost-efficient way to place bullish bets on specific stocks. Remember, this is not the only way you can use call options. The beauty of call options is that you can be creative.
For example, what happens if you’re long on call options, but think there will be volatile times instead? Well, you could purchase put options to turn your initial play into a volatility trade. However, you must be comfortable with the nuances of trading call options before you take the plunge. Do your research on call options, learn what works and what doesn’t, and make them another tool in your trading style to boost your profits.
If you’re new to the call options trading world, make sure to check out this guide to get you up to speed. And as always, utilize the extensive learning material and advice on call options and beyond that Raging Bull has to offer to new and seasoned traders alike.
Jeff Bishop is a lead trader at WeeklyMoneyMultiplier.com and widely recognized as the Mensa Trader. He runs short-term trading strategies, using stocks, options, and leveraged ETFs.