What are call options?

Buying call options is a great way to gain leverage in your account as the stock makes a nice sized move. They can be used to increase your profit potential and in some cases decrease your risk.

What a call actually is is an agreement between a buyer and a seller that allows the buyer the right to buy a stock at a certain strike price on or before a given date. For this right the buyer gives the sell a premium up front.

So, there are two ways to make money using a call. You can either sell the call in a form of a covered call or you can buy the stock and profit if the stock goes up. Let’s pretent we are going to be a buyer.

We buy a call with the strike price of $45 on stock XYZ. For this right we pay the seller $4, now we can buy the stock at any time during the next 2 months for $45.

Our Max profit is infinate. If we own the call on the stock and the stock goes up to $60, we would be able to buy the stock at $45 and sell it at $60 for a profit of $15.

And remember it only cost us $4 to get this right so if that happened we would have a profit of 275%. Most traders use call options to try to hit large profits in a short amount of time especially when you compaire it to stocks.

If we had bought the stock for $45 and it went up to $60 we would have profited 33% a nice profit, but no where near what we would have made if we bought the call.

Another great thing about calls is that they your limit your max loss to what you invested. If you invested $4 into a call the most you can lose is $4. The losses can be much smaller then buying the stock as well.

If you bought the stock at $45 and the stock goes to $20 you would have lost $25. If you bought the call for $4 and the stock goes to $20 the most you can lose is $4.

Just a helpful little hint, when you are dealing with call options you are not dealing with a long term strategy. Calls eventually expire and if the strike price is out of the money the option will expire worthless.

If you are trying to build a long term portfolio with call options you might wake up one day to find out you no longer have a portfolio.,

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Instead you should use these options when you are expecting a big move in the market. And of course any option plays you may have should make up only a small portion of your total portfolio.

This way of you lose 100% if what you invested it is not going to cripple your account.