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How do I Trade Call Options?

Jim B.
Jim B.

Call options provide an options buyer with the opportunity to buy 100 shares of some particular security at some point in the future. The investor holding a call option on a stock hopes that the price of the stock will rise in the near future. When that occurs, the investor can profit from the options contract by exercising the option to buy the shares and benefiting from their increased value. Another way to trade call options and gain a profit is to sell the options, which have a value all their own, when the price for the contract goes up.

Options are commonly used by investors who practice derivatives trading. Trading derivatives involves an investor speculating on the price of some underlying security, like stock shares, without ever having to purchase the security itself. Such trading allows investors the flexibility to get in and out of investment opportunities and the chance for big profits in a much shorter time span than if they actually owned the underlying stocks. Call options are a relatively low-cost way for investors to profit from a security that has the potential to go up in price.

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Before trading call options, investors must acquaint themselves with the terminology inherent in the practice. The cost of buying the contract on a call option is known as the premium, and it is usually a fraction of the price of the underlying security. When the security's price goes above a predetermined price known as the "strike price," it is often referred to as being "in the money." It is after that point that the contract holder may buy the shares at the strike price. Finally, each contract comes with an expiration date, after which the contract becomes worthless.

When an investor buys call options, it means that he is confident that the securities underlying the contracts are going to go up in price. If that occurs, the investor has the opportunity to buy the shares at a price lower than what they may currently be trading. An investor who times the move correctly can buy the shares at the strike price, sell them at their peak value, and pocket the difference.

It is important to note that the investor buying call options is not obligated to exercise the options should the strike price be reached. The investor may wish to sell the contract to another investor at some point, thus pocketing the difference in the premium payments. One other thing the buyer of a call option should realize is how strike prices and premiums are related. A general rule is that a higher strike price requires a lower premium payment by the buyer, while a low strike price commands a higher premium from the seller.

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