By: Montana Timpson
Buying call options is bullish, by nature, representing an optimistic view on the rising price of underlying shares. With market news dominated by unprecedented short squeeze phenomena, recent tech earnings and the record number of active traders in the US market, we’re going back to the foundations of call options — and examining the basis of positive speculation on assets as a whole.
Call options are financial contracts that give the option buyer the right — but not the obligation — to buy a stock, bond, commodity or asset at a specified price at a specified date (European style call) or within a specific time period (American style call). In short, a call buyer’s profit is linked to the increase in an underlying asset’s price.
For options on stocks, call options give the holder the right to buy 100 shares of a company at a specific price, referred to as the “strike price,” up until, in the American style, or at, in the European style, a specified date, known as the “expiration date.” For a given asset, there is typically a multitude of available options at different strike prices and expiration dates. A call option buyer may hold the contract until the expiration date — at which point they can “exercise” the option and take delivery of the 100 shares of stock at the strike price, or they can sell the options contract at any point before the expiration date at the market price of the contract at that time. The market price, called the “premium,” is the price paid for the rights that the call option provides.
Make sure to fully understand an option contract’s value and profitability when considering a trade. Though option contracts give buyers the opportunity to obtain significant exposure to a stock for a relatively small price, they can also result in a 100% loss of premium if the call option expires worthless due to the underlying stock price failing to move above the strike price. The benefit of buying call options, in this way, is that risk is always capped at the premium paid for the option, in contrast to a losing short position, where losses can theoretically be unlimited.
Some professional traders use call options to generate income through a covered call strategy, in which a trader writes a call option contract while concurrently owning an equivalent number of shares of the underlying stock. Potential benefits of this strategy for professional traders include slight downside protection (the premium received for the calls effectively reduces their net purchase price of the stock) and the ability to declare premiums received from selling a covered call as income.
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