Buying Call Options

Buying calls is the most basic options trading strategy.

A call options buyer is a trader who believes in a rising market and expects to profit from an upward price move. By buying calls an options trader is buying a right to purchase the underlying stock at a specific price, at or before the expiration date. The call options buyer profits if the underlying stock price moves up and conversely he/she loses money if the price of the underlying stock moves down.

The maximum loss a call options buyer may experience is the premium paid for the calls. The maximum profit is theoretically unlimited.

Suppose the QQQ is presently trading at $43.00 per share. If you are in a bullish mood you could purchase a QQQ call option to greatly leverage your profits from your anticipated upward movement. You may purchase QQQ calls with a strike price of $43.00 and an expiration date a couple of months out for about $2.00 per contract, at the present price. If the price of the QQQ rises by 1% your call option may increase in price by 15-20%. If you are correct in the market direction your profit is potentially unlimited. The more the underlying stock rises (in our example QQQ) before an expiration, the bigger your profit. On the other hand, your risk is remains limited. The most you can lose is the price that you paid for the option, and from the example above that would be $2.00 per contract.

Generally it is recommended that traders purchase calls that are at-the-money or in-the-money, because this lowers the risk of losing the premium, when they are purchased. Even though the out-of-the-money options are much cheaper and provide greater leverage, they are considered more risky.

When you buy call options you cannot hold them as stocks. Options loose their value with time - the closer they are to the expiration the cheaper they become. When a trader initiates the position, it is important to set a specific target price for the option and it is a good strategy to sell and take profits, when the price reaches the target. As the price is rising, be careful that greed does not become a too strong a motivator and make you want to increase your price target. Doing this, a trader can sometimes turn a winning position into a losing position.

It is important to analyze your expectations for the market and for the underlying asset before selecting your strategy.

When you have call you have three options to exit the trade:

• You can let the call expire and lose the premium.
• You can exercise the call to receive the stock at the strike price of the option and by selling the stock at the current market price collect the difference.
• You can sell the call. In this case you can make money if the price of the premium rises in value due to a rise in the underlying stock.

Another Example:

A stock trades at $40, you might buy a call option with a strike price of $44 for three month at a price $1.

• If the stock goes to 50 in the next three month you can exercise your call option and demand that the call seller sell you stock for $44. You can sell the stock for a market price $50 and keep the difference $6 (600%).
• On the other hand if the stock declines to $35 it doesn't make sense to exercise option and buy stock for $44. Your options would expire worthless and you would be out of $1. in this case the seller of the call would make $1.