Posted on 13 August 2011.
Trading call options is a powerful trading tool that any stock market trader or investor should consider to give them an advantage when trying to profit in the stock market. Trading call options is not as simple as buying and selling stocks because making money holding a call option requires the underlying stock that the call option is based upon to go above a specified price (strike price) before the option expiration date.
An Option is a financial product that is comprised of a contract to buy or sell a specific amount of the option’s underlying instrument (which is a stock or commodity) at a specified price on a future date.
An Option contract to buy a specific amount of the option’s underlying instrument at a specified price on a future date is known as a Call Option.
There are a number of trading strategies associated with trading call options. Since call options have an expiration date, timing is very important when considering the use of call options in a trading strategy. Stock market traders and investors use call options in their trading and investment strategies for a variety of reasons, including: speculating that a stock is going to make a move higher, purchasing a long position in a stock via options at a fraction of the price of actually purchasing the stock, and to protect the downside risk of buying a stock, if the trade does not work out and the stock falls in price.
A trader or investor buys a call option to profit from an anticipated move higher in the price of the underlying stock that the call option is based upon. If the stock that a call option is based upon reaches the call option’s target price (strike price) and rises to a level above the target price that is high enough to cover the premium (fee) that is paid to purchase the option, then the call option trade is profitable. The higher the underlying stock moves above the target price for the option before the expiration date, the higher the profit is for the buyer of the call option. One of the advantages of using call options to play an anticipated move higher in a stock is that if the underlying stock moves significantly higher, the call option could increase by a much higher percentage than the actual percentage move in the underlying stock.
Traders and investors also buy call options in lieu of buying shares of a stock because call options can be purchased for just a fraction of the cost of buying shares of a stock. This allows traders and investors to commit a much smaller amount of money to play a stock’s anticipated price movement higher versus actually buying the stock, which frees up their trading and investing capital for other purposes.
Call options are popular with some traders and investors because they protect the downside risk of playing an anticipated move in a stock’s price. If the stock does not move higher as anticipated, and instead moves lower, the loss associated with buying a call option is limited to the premium that is paid to buy the call options on the underlying stock. Whereas, the loss associated with buying a stock can be substantial if the stock makes a significant unanticipated move lower in price.
Those who wish to start trading call options and using call options as part of their investing and trading strategies are encouraged to learn as much as possible about the options market and the various ways call options can be traded.
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