Understanding Call Options Can Enhance your Trading Skills

Call options give you the right to purchase a specific stock at a specific price sometime in the future. For this right, you pay the seller a fee which is determined by market forces. Thus, after you have purchased the option, you have identified your maximum downside and while the option is active have unlimited upside potential. The main benefit of options is the leverage which they give you.

Call option definition

One option controls 100 shares of stock. Therefore, when you look in a newspaper or on the internet for a stock option quote you may see Dec 40 $2.50. What this means is that for $250 you can buy the right to purchase 100 shares of stock for $40 up to the close of trading on the 3rd Friday of December. No matter what month you purchase, options always expire on the 3rd Friday of the month.

Traders who buy calls are looking for an increase in the stock price and want to use the leverage of the option to increase their return.

The cost of an option is mainly dependent on two factors – distance to the strike price and time to expiration. In the above example if you are purchasing a December option in the middle of October then you are receiving approximately two months worth of time value. If you purchased a January option with the same strike price it should cost more. If the stock is selling at $41 you are also receiving $1 (41 – 40) of intrinsic value. If the stock was selling at $39 the option would cost less as the option would contain no intrinsic value.

After you purchase the call but before expiration, you can either resell the option or call the stock away from the seller provided you pay them $40 per share. However, after the option has expired one of two things will happen. If the stock is below $40 the call option will expire worthless and you will have lost the money you used to purchase the option. On the other hand if the stock is above $40 your broker would generally assign the stock to you and remove $40 per share from your account plus applicable commissions.

Now that you understand the basics of call options you can learn how to use call options as part of your stock trading strategies.

Get started trading options

If you are interested in obtaining more information on how to trade options, you may want to learn about a different type of option trading strategy which was featured in "Multiple Streams of Income" by Robert Allen. When you are looking at different systems being offered you should try them out for a while, see if they fit your trading style and determine if you are being given good information that will ultimately help you progress as a trader.

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