Buying Call Options, Buy Call Options, Long Call Options
Call buying is the simplest and most common type of option investment.
Here’s how it works…
Buying a call is an option to buy a particular stock at a certain price for a limited period of time. It’s a bullish position. A call option increases in value as the price of the underlying stock goes up.
There are three primary benefits to a call buying strategy.
First, risk is limited to the premium paid. No matter what happens to the underlying stock price, you can never lose more money than the initial cost to open the position.
Second, reward is unlimited. The higher a stock price climbs, the higher the value of a call option climbs.
Third, buying a call option provides a great deal of leverage. That means a small increase in the underlying stock price results in a large increase in the option value.
Here’s an example of buying call options on Exxon Mobil (XOM)…
Let’s say XOM is trading for $80 per share. Let’s assume a call option on XOM with an $85 strike price and an expiration date 6-months in the future sells for $3.00 per contract.
Remember, each option contract controls 100 shares of stock. So, buying one contract will cost $300. An investment of $300 gives the investor the right to buy 100 shares of XOM for $85 anytime in the next six months.
In a nutshell, if XOM’s price goes up, so will the value of the call option.
Let’s take a look at three possible outcomes at options expiration. Don’t forget, you have the right to sell the option at any time. There’s no need to wait until expiration to sell. But talking about the value at expiration is an easy way to illustrate the potential outcomes when buying call options.
First, let’s look at breakeven. In this scenario, you get your $300 investment back. The breakeven on our XOM call option is $88 ($85 strike price + $3 option premium). In other words, if XOM’s price goes up 10% to $88 during the next six months, the call buyer will breakeven at expiration.
Second, let’s look at a 100% loss. If XOM is trading for less than the $85 strike price, the option will expire worthless. The good news is you can only lose the $300 premium. Even if XOM stock’s worth 1 cent, the most you lose is the premium you paid to buy the option.
Our third scenario is the most exciting, and the reason many investors buy call options in the first place… profits!
If XOM is worth more than $88 at expiration, you’ll make a profit. Let’s say XOM goes up 20% to $96. The option would be worth $11 ($96 – $85 strike price). That means our $3 call option increased an eye-popping 266%!
In other words, a 20% increase in the underlying stock caused the option to increase by 266%. That’s the type of leverage that gets option traders’ juices flowing.
Category: Options Trading Strategies
