When Learning How Call Options Work, Investors Should Know They Have the Right, But Not the Obligation, to Buy a Stock at a Predetermined Price and Time.
What is a call option? How call options work is by giving the buyer the right to buy 100 shares at a fixed price (strike price) before a specified date (expiration date). Likewise, the seller (writer) of a call option is obligated to sell the stock at the strike price if the option is exercised.
For example, the purchase of the XYZ 100 strike call for $1 would only risk the $1 paid. However, that $1 for the call is actually $100 as each 1 call represents 100 shares of stock. And thus when you pay $1 for a call, the total risked is actually $100. If the stock were to close at 100 or below at expiration, the call purchased would be worthless. You would have lost $100. The breakeven on the trade is at 101. If the stock were to go above 101, the holder of this call would make $100 per call purchased per point above $101.
Therefore, because of how call options work, the most you are able to lose is the premium you paid.
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How Call Options Work: Risks with Call Options
In our video How to Buy Call Options, Jacob Mintz, Cabot’s options expert and chief analyst of our Cabot Options Trader and Cabot Options Trader Pro advisories, explains why call options are only as risky as you make them.
How Call Options Work: What To Do and What to Avoid When Purchasing Call Options
Call options can be extremely beneficial and they can help you gain upside exposure to profitable growth stocks. While risk obviously does accompany call options, (although less risk than regularly traded stocks) there are precautions you can take to significantly reduce risk.
How Call Options Work Tip #1:
First, the best time to purchase a call option would be when the specific price of a stock is predicted to increase. This eliminates substantial risk and increases your chances of receiving profitable returns.
How Call Options Work Tip #2:
Second, avoid highly volatile stocks if you are planning on purchasing a call option. The trends of highly volatile stocks can be unpredictable and a sudden downtrend could cause you to lose your investment.
Overall, call options can be a profitable alternative to regularly traded stocks. However, investors should make sure that they invest in call options properly and at the right time to ensure that their returns will be positive. To learn more about call options, click here to read “What Are Call and Put Options”, by chief analyst of Cabot Options Trader, Jacob Mintz.
Do you have a better understanding of how call options work? What other questions do you have?
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