What is a Call Option? And Why Should I Buy a Call Option?

The how and why of long call options

Digital Content Manager
Oct 12, 2018 at 10:14 AM
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    In the simplest terms, a call option gains value when the underlying stock rises. Buying a call is essentially a bullish bet that gives the trader the right, but not the obligation, to purchase the underlying shares for a specific price (the strike price) before an expiration day.

    Let's say Stock XYZ is trading at $39.50. A trader speculates that the price will rise in the short term. He or she then purchases a November 41 call, expiring on Nov. 16, for a $1.50 premium.

    The hope is that the underlying asset will rise well above $42.50 by the expiration date, which represents breakeven (call strike + premium paid) on the trade. Specifically, the trader's profit will accumulate the higher XYZ rises above $42.50 before expiration, with profit potential theoretically unlimited.

    The contract can be sold to close before it expires, in which case the trader's profit would stem from the gain in the option's premium over the lifetime of the trade. Or, if the trader wants to own the shares of XYZ, he or she can exercise the in-the-money call -- meaning they can buy the stock for $41 per share (the strike price), representing a discount to what they'd pay on the Street.

    So, why buy call options instead of just purchasing the stock outright? For one, there's limited risk involved in purchasing a call. The trader can only lose as much as the premium he or she initially paid. If Stock XYZ in the example above plummeted to $30, the shareholder would be out big bucks, while the call buyer would be out just the $1.50 paid at initiation.

     

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