Call Option: The Basics of Understanding the Selling and Buying of Call Options in the Exchange Market
As a new investor in the world of stock investing, you might be wondering how it is possible for stocks to increase in value. There are a number of ways that this can happen, but one example would be if an investor purchases a Call Option on that stock. What does this mean? A call option gives the buyer the right to purchase 100 shares at a predetermined price within a certain time frame. So what can investors do with these options? They can sell them at any point or use them as protection against downside risk. The best thing about buying and selling Call Options is that they have "limited downside risk."
This blog post will discuss what it exactly means to acquire these call options means for your portfolio.
What are call options?
Call options are derivative securities that allow an investor to buy or sell a stock either at a predetermined price or at market price. A Call Option gives the buyer the right to purchase 100 shares of a stock at a specific price by a certain time frame. If the share price rises above that level, your stocks will increase in value if you purchase a call option at this moment.
On the other side, if the stock falls below the predetermined price, then you will lose your initial investment. Here, instead of buying 100 shares at a higher price, it is possible to purchase one call option contract, which entitles you to buy 100 shares at a predetermined price. If market conditions are not in your favour and the share price decreases, then you will simply let the contract expire and not lose more than your initial investment.
Call Option Example
You believe that XYZ stock is going to rise in value over the next month, so you purchase one call option for $100 (with a predetermined price of $10). If, after 30 days, XYZ stock has risen by, let's say, 20%, then the call option will increase in value by 100% (20 * $100) = $200. If you sell your contract at this price, you make a profit of 200 – 100 = $100 (minus any trading fees). However, if, after 30 days, XYZ stock fails to rise above the predetermined price of $10, then your contract expires and is worthless. You can then sell it for 100 – 0 = $100 (minus any trading fees). In this example, your initial investment was $100. If you add in any trading fees to this scenario, they will be minimal because the contract would have been sold before expiration.
How to Buy Call Options?
Since buying options is more complicated, I will break it down into smaller steps for you to follow. You need to do is open an account with a reputable online broker.
After opening your account, send in your account verification documents. Once you have your account open and funded, you will finally be able to start trading.
One of the points you should note: call options are also denominated in 100 increments. The minimum purchase is, therefore, $100 (since it's equal to 100 x $1). There is no higher set amount you can invest in a single call option, but you need to understand that you should not invest more than you can afford to lose.
We also need to mention the "expiration date" for this type of option. As already mentioned, they are settled on the day of expiration. So if you sell your 100 contracts with an expiration date of May 14th, you need to close your position (buy/sell) on May 14th. In case the option gets out of date out of the money, your trade will be closed automatically by the system and every dollar you invested in it will be lost.
The same happens if you don't have enough money to cover the cost of closing the position. We should also mention that there is an upper threshold for buying these options. You can't buy more than you can afford to lose. If the option prices go up, the system will either close your position automatically and return you your investment (if your position was already open and in the money) or leave it open and keep on trading with your investment according to its rules (if your position was not in the money and you bought it with a pending order).
The moment you buy an option, its price goes up. That's called "the premium." You can see what that number is by looking at any exchange interface. These numbers aren't set in stone, though, because the exchange interfaces don't show certain details from an option's order book.
What they show, though, is a bid price and an asking price. The difference you get between the asking price and the bid price is called "the spread."
How to Sell Call Options?
Let's say you're into short-term trading and want to sell a call option. You can easily sell an option by following this;
The first step is to assess if there are any open orders to sell the call you're interested in, and if yes - how many.
In the list of open orders, click on the "Quantity" column to order them from largest to smallest. Then look for a number of open orders that is larger than or equal to the quantity you want to sell - in our case, it's 100. You can also see there is at least one market order selling ten units of this option, but we don't want our trades to go through right away.
In the example given, there are a few open orders to sell XBT20150115C, all quantities from 0 up to 100 units. The order book also shows that 100 units are currently being sold by a market order. We can probably expect to sell our 100 units at a slightly higher price. So let's place our limit order to sell!
Remember that not all exchanges have the same APIs, so these formats may or may not work for you. The above link also contains examples of how to use each of these exchanges. Please feel free to leave your questions in the comment section below if your exchange is not listed.
Now that you've mastered the basics of placing limit orders, here's a little trick to save some money on fees. Every time you submit a limit order, your trade fee will be based on what portion of the "bid size" was filled. If there were enough other orders in front of yours and it doesn't fill the whole thing, your trade fee will be calculated as if you managed to buy/sell all of it.
So let's say there is already 100 BTC worth of bids in front of yours, and you only manage to sell 10 BTC. If that was your entire order and you still pay "0.1%" as a fee,
Pros and Cons of Trading Call Options
1. Trading call options is cost-efficient as they come with a huge leveraging power
2. You can make use of options to avoid the risks that you may predict on your invested principal
3. The options give you a high return potential on your invested principal.
4. The call options expose you to more investing strategies.
Cons of Trading Call Options
1. Selling call options against your stock means you will automatically cap your profit potential if the stock you sold will rise in price sharply.
2. There is a possibility of you losing 100% of the premiums paid.
The importance of call option trading is not to be underestimated. In fact, trading call options is one of the most important aspects of any given investment strategy. But what exactly are they? Call options lets you buy a stock at a predetermined price before the expiration date and sell them for higher prices if necessary. It is a venture that is worth trying!