Friday, May 29th, 2020

When is Trading Call Options a Good Option?

November 24, 2009 by T.D. Thompson  
Filed under Call Options, Options Trading Tips


Of all the means of making a profit in the stock markets trading options is sometimes a good option. In the American stock markets you can buy or sell stock options. You can buy or sell either puts or calls in options trading. Which you do depends upon where you think a stock is going and how soon.

Let’s look at what our options are in trading call options. There are call options and put options each of which you can buy or sell. You will buy or sell call options depending upon whether you believe a stock is about to go up or down.

An options trader who thinks a stock’s price will go up can purchase the stock or, for a much lesser amount, purchase a call option on stock at or near the current price. This means the options trader has the right to purchase the stock at any time up until the expiration date of the call option, at the set price called the strike price or the exercise price regardless of what the market price, the spot price, is. If the stock does not go up the trader is under no obligation to buy. If the stock goes up the trader has the right to buy.

The price of a call option is based on what traders think is the value of the option and upon the difference between the set price for buying the stock and current stock price. If the consensus of options traders is that the stock is very likely to go up the price of the call option will reflect that fact and be more expensive. If options traders believe that the stock price will go down or stay the same then the price of the option will be low.

The risk in buying a call option is that the stock will not go up enough (or not at all) to warrant exercising the option and buying the stock. The risk of selling a call option is that the stock will go up spectacularly and you will miss out.

In selling call options you are betting that the stock you own will not rise sufficiently and that at the end of the term of the option you will still hold the stock and be richer by the price of the stock option you sold. In general only owners of stock will sell options because, if the price goes up spectacularly, they will not need to go into the market and buy at a high price in order to sell the stock at the previous low price.

Options traders who buy call options typically are not interested in long term stock ownership. The idea is to use a smaller amount of capital to purchase options on stocks that are about to go up. When that happens the purchases exercises the option, buys the stock and promptly sells at the higher price. The gain for the successful buyer of a call option is the higher price minus commissions and minus the price of the option.

Both buying and selling call options have their place depending upon whether or not you already own the stock and whether you believe the stock’s price will go up or down. Investors typically sell call options and traders typically buy call options.

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