The Call Option…Getting Started

A call option is a particular type of option trade. When you read about options trading, the first two terms you learn are often call and put. These are like the yin and yang of options investing. A call lets you speculate that underlying asset prices are going to go up. The put lets you bet that the prices of underlying assets are going to fall.

Many options traders begin their trading career in this type of investment by purchasing call options. A call option gives you the right, but not the obligation, to buy or sell an underlying futures contract or stock at a future date for a specified price. You “go long” when you have the right to purchase. You “go short” when you have an obligation to sell.

When a call option is exercised, the seller of the option must give up control of the stock or futures contract. If the call option is allowed to expire, the seller gets control of the underlying asset back. So you can see that a call option is an actual contract between a buyer and seller and there are specific terms in the contract.

Two of the key words in the definition of a call option are “right” and “obligation”. The call option gives you a right to exercise the option, but you are under no obligation to do so. On the other hand, the seller has an obligation to sell you the underlying asset if you decide to exercise your right.

The Goal

The goal of an investor buying a call option is to make money on rising asset market prices. The hope is that the price of the asset will rise and the option price will enable the buyer to purchase the asset below market price. If the market price never reaches the strike price, then the option can simply expire. The buyer loses the premium and the transactions costs but that is all.

That is another reason why beginning investors choose call options at first. The upside profit potential is virtually unlimited. Of course, the strike price and the timing of the contract will determine if the call option buyer is successful.

Naturally the seller hopes that the option stays out of the money. In that case the seller gets to keep the underlying asset plus the premium and fees paid by the seller.

Call options can be purchased for stocks, bonds, agricultural commodities, precious metals, interest rates and many others. Once the call option is in place, the seller cannot sell the underlying asset included in the option terms to anyone else.

Watching the Market

Investors learning how to complete successful call option transactions can watch the market for a period of time and witness how the big investors perform. When the market indicates large volumes of call options during the day for a particular asset then you can probably assume the investors expect the price to rise in the near future. The charts indicate expiration dates so you can even see how soon the investors expect the prices to rise.

Call options naturally play a role in options strategies. For example, call options are used in long and short straddles. A straddle is a option strategy that is a spread. For example, a long straddle balances a call option and a put option in a way that minimizes risk of loss while maximizing speculation.

Related posts:

• Preparing for Trading Options