For many investors, the idea of trading options is an intimidating proposition. Although options trading does carry an introductory learning curve that may be somewhat steeper than ordinary stock trading, this particular method of investing can be quite rewarding for those who are willing to invest the time and effort required.
Buying calls is one aspect of options trading that can result in substantial gains for savvy investors. Understanding what exactly a stock call is and how it can be purchased will provide an excellent foundation for your future forays into this exciting world of investing.
A stock call is one form of options contract that is bought and sold on a regular basis. A stock call provides the buyer of the contract with the ability to purchase a specific number of shares in a company for an agreed-upon price at a specific period of time in the future.
The Basics of Options Contracts
In options trading, investors are essentially making a well-researched prediction as to whether or not the value of a particular stock will rise or fall over a specific period of time. By definition, an options trade is any contractual arrangement between buyer and seller that allows the buyer to purchase or sell a particular asset for a specific price at a specific point in time.
The two forms of options contracts in use today are the call option and the put option. These two options contracts differ in the specific privileges they grant to the buyer of the contract. In a put contract, the buyer has the opportunity to sell an asset at a specific price at a mutually agreed upon point in the future. A call contract offers the opposite – the buyer of the contract has the opportunity to purchase an asset for a specific price at a pre-arranged, future point in time.
Understanding the Call Option
The power of the call option lies in the ability to "lock-in" a price for a future purchase well in advance of that particular transaction. In exchange for allowing a buyer to fix the future price of a given asset, the seller receives a premium, which is a sum of money that acts as a form of retainer for the contract.
For example, if an investor wants to buy a call option contract for 3,000 shares of a given company at $412 per share, they may be required to pay a $2,000 premium to purchase the contract. The size of the premium involved in the contract will fluctuate depending upon the level of perceived risk involved in the contract for both buyer and seller.
Options Contract Buyers and Sellers
Buyers and sellers in options contracts have distinctly different responsibilities and privileges. The buyer of an options contract is under no obligation to buy or sell the underlying asset when the contract date arrives. Although the premium they have paid at the onset of the contract was meant to offer them exclusive access to the asset in question, it does not bind them to the asset. Unlike options buyers, those who are selling the put or call contracts are legally obligated to buy or sell the specific asset at the agreed-upon date, if the buyer of the contract chooses to exercise their rights.
In order for the buyer of a call option contract to make a profit from the arrangement, the value of the underlying asset must increase beyond the "strike price" of the contract. A strike price can be defined as the specific price point at which the buyer of a call option can exercise their right to buy the underlying asset.
For example, say an investor purchases an options contract for 500 shares at $20 each, with a strike price of $70. They will only be able to exercise their rights in the contract once the value of the shares exceeds $70. If, at the time of contract expiry, the value of the stock is below $70, the options contract holder will not be able purchase the shares.
Purchasing Call Options
Both put and call options contracts are sold through identical markets in the United States. Much like traditional stocks and securities are sold through exchanges such as the New York Stock Exchange, options contracts are bought and sold via similar platforms, including the Chicago Board Options Exchange. Other large options exchanges in the United States include the Boston Options Exchange and NYSE Arca.
Retail investors who are interested in purchasing call options can do so through a variety of online exchanges. Many of the more popular online brokerage firms operating domestically, such as TD Ameritrade and Charles Schwab, allow investors to research and purchase options contracts through their web platforms.
Keep in mind that options contracts will still carry a variety of commission fees. Investors should carefully examine their own budget and their investing goals and objectives before beginning to purchase options contracts. As always, thorough research acts as the best safeguard against unexpected financial loss.
Considering Options Trading Risks
Options trading has gained a degree of popularity due to its unique method of buying and selling contracts. That being said, it is essential to weigh all of the potential risks associated with these contracts before jumping into this fast-paced arena.
Given the fact that the premium investors pay to secure buying or selling rights through an options contract is typically far less than the equivalent price for the same amount of shares, many investors will enter into contracts on a much larger number of shares than they are actually capable of purchasing at that time. This process, known as leverage, acts as a means to enhance profits from successful contracts. However, leverage can also dramatically increase the scope of losses in the event that an options contract fails to settle "in the money" for a specific party. In such situations, investors may be legally liable to purchase a volume of shares that they simply cannot afford.
When first entering the world of options trading, new investors should take the time they need to master the inner workings of call and put contracts, devoting considerable effort to exploring the relationship between leverage investments and maximum profit/loss. While there certainly is no guaranteed method for staving off undesirable losses, a keen awareness of current market conditions and awareness of recent opportunities will help ensure that you make the best decisions possible regarding your contracts.
Consulting Options Trading Experts
If you have any additional questions about options trading, you may benefit from speaking with a financial investment expert. The online brokerage platforms mentioned earlier include a variety of helpful educational resources in addition to customer service professionals. In the event that you are uncertain how to best proceed with your options contract purchases, you should consider speaking with a representative from the brokerage first.
Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community. Ryan's work has been featured on PocketSense, Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.