Buying calls is considered to be a bullish position on an underlying stock value. The investor has the chance to partake in the rise of the stock’s value for the term of the contract with a predetermined risk. Most investors will look to sell their contract at a profit, while others may choose to exercise their right to buy the underlying shares.
When buying calls, it is important to understand, that in order to exit a call you have three options. First, you can let the call expire with no value (or in other words lose the premium paid for the option). Second, you may exercise the call at the agreed upon strike price, and then turn around and sell the stock at the current market price. You then profit from the difference as a result. Third, you may sell your call when it rises in premium in tandem with the rise in the under lying stock value.
The primary benefit of buying calls is the limited risk of capital. The investor has a much smaller cash layout with a limited downside loss, and unlimited upside gain. Conversely, the options investor does not have the same rights of the individual shareholder, such as dividends and voting rights.
The idea is that the potential profit on a long call is unlimited as long as the underlying value continues to rise. Additionally, the potential loss is limited to the premium paid for the contract.
Buying Calls is a long call strategy that is best used in a bullish market where a rise in the price of the underlying stock is expected. Furthermore, when you elect to buy a long call option instead of the under lying stock, you increase your leverage and minimize the inherent risk of the trade. The most you can lose on your purchase is the cost of the premium.
Buying Calls can be a great way to increase your participation in certain stocks without tying up a log of funds. Options permit you to control a greater number of shares for less capital.
The Chicago Board Options Exchange (CBOE) provides this concise definition for Buying Calls. Buying an equity call gives the owner the right, but not the obligation, to buy 100 shares of underlying stock at a stated price (the strike price) This can be done at any time before a specific time (the expiration date). This is considered a bullish strategy since the value of the call tends to increase as the price of the underlying stock rises. This gain will increasingly reveal a rise in the value of the underlying stock when the market price moves above the option’s strike price.
The return potential for the long call is limitless as the underlying stock continues to rise. The financial risk is restricted to the total premium paid for the option, no matter how low the underlying stock declines in price. The break-even point is an underlying stock price, that is equal to the call’s strike price, plus the premium paid for the contract. As with any long option, an increase in volatility has a positive financial effect on the long call strategy while decreasing volatility has a negative effect. Time decay has a negative effect.
Option Trading requires specific training, but offers increased benefits of protecting your capital while increasing your profits.
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