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What are the Best Tips for Call Option Trading?

Article Details
  • Written By: Jim B.
  • Edited By: Melissa Wiley
  • Last Modified Date: 25 April 2018
  • Copyright Protected:
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    Conjecture Corporation
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Call option trading refers to the practice of investors buying and selling the option to buy 100 shares of the security underlying the option. Buying a call option means that the investor thinks that the price of the underlying security will rise, while selling it means that the investor thinks it will stay steady or fall. Those buying a call option should be looking for a stock whose price is currently at a low point but has the potential to soar upward. The best strategies for selling in call option trading include buying the underlying stock as a hedge against a price rise and manipulating the strike price, which is the predetermined price above the stock's current price at which a call option becomes profitable for the buyer.

Option trading offers expert investors the opportunity for bigger profits than normal stock trades, especially if the investors can time their moves correctly and accurately anticipate the move of a stock. Call option trading involves several different elements that the investor must understand. The premium is the amount paid for the option, which is the quoted option price multiplied by 100, as 100 is the amount of shares that might be bought for the option to be exercised. Once the option goes above the strike price, which is set above the current price of the underlying security, the buyer may exercise the option, but only if it occurs before the expiration date on the option.

Buyers involved in call option trading are looking for stocks that may be struggling and have the potential to rise quickly before the option contract expires. These buyers of call options should not be afraid of a stock showing volatility, which means that it has large swings up and down. This is because the only thing risked when buying call option is the original premium payment. A big drop in the underlying stock is the same to the option buyer as a small drop, while a big jump means the possibility of a huge profit when exercising the option to buy the shares or closing it out by selling it.

On the flip side of call option trading, the seller has to be wary of volatility, because the potential for loss is huge. If unsure about the volatility of a stock, the seller can also buy shares of the underlying stock. In this strategy, known as a covered call option, a rise in price means that the ownership of the shares can offset the losses on the option. Ideally, the stock would rise just a bit but stay below the strike price, in which case the seller would pocket the premium while his shares also rise in value.

Moving the strike price can also help the seller of call options protect her investment. Strike prices that are closer to the current stock price can command higher premium prices, so the seller should use lower strike prices if she believes the stock price is stagnant. Keeping the strike price higher means that the premium gained will be less but the risk of loss is lessened.

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