Call Options

What are Call Options?

Call options give an investor the right, but not the obligation, to buy a stock, commodity or other financial instrument at a specific price within a specific time frame.

Buying Call Options

Investors buy call options typically to profit from an increase in the price of the underlying stock or security, or to "lock in" a good purchase price if they think the underlying is going to increase in price.

Buying call options is a popular strategy for both novices and expert option traders because the strategy is somewhat simple: Buy call options on stocks (or other types of securities) that you think the price will go higher than the strike price of the call options plus the premium created by the expiration date. Investors also buy call options when they think the premium for the call options will increase enough to outpace the time decay as expiration nears. In both cases, if the investor is correct, he may be able to realize a positive return. If he is wrong, he only loses the premium for the call options, which is usually much less than if you had bought the stock or equity outright.

Typical Purpose

To lock in a good purchase price on the underlying, or to potentially profit from an increase in the price of underlying.

Market Sentiment

Bullish to Neutral.

Reward Potential

Unlimited, depending on how high the underlying security could reach.

Risk Potential

Risk is limited to the price (premium) paid for the option.

Selling Call Options

Investors sell call options (commonly referred to as "Call Writing") to earn money from the premium received (the price a buyer paid for the call options) or to lower their net cost for buying a stock or underlying security.

Many investors that sell call options do so to earn income from stocks (or other underlying equities) that they already own (this is covered call writing.) This is a relatively conservative call options strategy. Investors who do this hope that the call options will expire out-of-the-money, and the buyer won't exercise the option. The seller (or writer) of the call options would keep the premium paid as income in this case.

A riskier strategy for selling call options is naked call writing. This is writing options on a stock that you don't own. Investors who do this are typically bearish on the underlying and want to take advantage of the decline. The risk here is that the underlying increases in value and the buyer wants to exercise the call options, which means the seller has to buy the equity at the current market price and then give to the buyer at the strike price.

Typical Purpose

To generate income from the premium received for the call options, or to lower the net cost of buying the underlying security.

Market Sentiment

Typically Neutral to Bearish.

Reward Potential

Equal to the premium received for the call options.

Risk Potential

Unlimited for naked call options, limited for covered call options.

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