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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.
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.
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.
I purchased the Online Option Trading Manual for two reasons. First, it allows me to critique what products I have on my site to make sure they deliver value to my readers and second it increases my trading knowledge. Dr. Cooper’s Online Option Trading Manual is definitely worth keeping on this site.
While the title Online Option Trading Manual seems to appeal only to option traders this is not the case as the first part of the manual deals strictly with stocks. First they find the stocks then they find the options. So if you are only interested in stocks, just ignore the options section or keep it in mind when you feel you are ready to add options to your repertoire.
While I will not go into detail, I found three really interesting tips in this manual and for the money, it was definitely provided value. After reading this manual there were a number of changes I made to my trading plans and some stated expectations to which I am now aiming.
While I was a little di disappointment that a complete trade from start to finish was not illustrated you can access a number of student trades which clearly show a compete trade including comments and returns on their website.
In summary, I highly recommend the Online Option Trading Manual as it will go a long ways to providing you the answers you are looking for and give you suggestions on how to improve your trading so you can start to trade stocks profitably.
Monte Carlo Simulator
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