Acall is anoption contract that gives the owner the right, but
not theobligation , to buy 100shares of the underlyingstock at a
specified price (which is known as thestrike price of the call) at
any time before a specific time (theexpiration date of the
Bullish investors would use calls because the value of the call
should increase if the price of the underlying stock goes up. The
potential profits for an investor owning a call are unlimited,
because the underlying stock can go up to any price. The maximum
possible risk on a call is limited to the total price paid for the
Changes in the price of the underlying stockwill lead to a
change in the value of the call, as will changes in the volatility
of the underlying stock. If the stock becomes more volatile, then
the call should go up in price, because there is a greater chance
that it will reach the strike price by theexpiration date . Falling
volatility decreases the chance that the underlying stock will rise
that much, so the value of the call should decrease.
In addition to being driven by the price and volatility of the
underlying stock, the call also changes in value based on how much
time is left before the expiration date. The call is less valuable
as it gets closer to the expiration date.
How traders use it
A trader who is bullish on a stock orindex could buy a call. There
are also option contracts available on some exchange-tradedfunds (
) andfutures . Traders can use calls on a number of
individualstocks , indexes like the S&P 500, or ETFs like the
SPDR S&P 500 (
. A call is a leveraged trade that allows the trader a chance to
enjoy relatively large rewards for a certain amount of risk.
As an example, consider
. If Apple is trading near $600 a share, 100 shares would
cost $60,000. Instead of committing that much to the stock, if
traders think Apple should continue going up in the next
few weeks, they could buy acall option that allows them to buy 100
shares of Apple for $600 (the strike price) at anytime in
the next two months (the expiration is 60 days away) for a price of
$32 per share (the option premium). This would allow them to
participate in any price rise for aninvestment of only $3,200.
If Apple reached $700 a share at the expiration date,
then the trader would make $6,800. This assumes they buy the 100
shares for $600 and immediately sell them for $700. The premium of
$3,200 would be deducted from the profits.
Call traders can close their positions without having to buy the
stock first and then sell it, and closing the position in this way
(by selling a call) would lead to the sameprofit . The options
trader would make a return of 112% on their investment. A trader
buying 100 shares of Apple would make 17% on their
If Apple closed below $632 on the expiration date, then traders
would suffer a loss of their entire investment since buying and
selling the shares would not cover the cost of the premium. But the
loss is limited to $32 per share, no matter how far Apple falls. If
the stock falls to $500, the owner of 100 shares would lose
$10,000, while the call holder would only lose $3,200.
The actual price move in Apple would determine the price of the
option. Calls can be bought or sold at any time and the trader
would be able to take a profit or cut any losses at any time during
Action to Take -->
Calls can be used as part of a trading strategy to increase profits
or limit losses whenever a trader thinks prices will rise. Traders
who are bullish in the short-term can use calls to obtain long
positions at a lower cost than buying the individual stocks.
Long-term options are available and traders can use them to create
low-cost, longer-term positions in a stock.
This article originally appeared on ProfitableTrading.com:
Call Options: Leverage an Upward Price Move While
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