You can profit from an increase in a stock’s price by purchasing a call.

Buying calls is popular with options investors, novices and experts alike. The strategy is simple: You buy calls on a stock or other equity whose market price you think will be higher than the strike price plus the premium by the expiration date. Or, you buy a call whose premium you think will increase enough to outpace time decay.

In either case, if your expectation is correct, you may be in a position to realize a positive return. If you’re wrong, you face the loss of your premium — generally much less than if you had purchased shares and they lost value.

Call Buying

Is buying a call worth it?

Call buying may be appropriate for meeting a number of different objectives. For example, if you’d like to establish a price at which you’ll buy shares at some point in the future, you may buy call options on the stock without having to commit the full investment capital now. Or, you might use a buy low/sell high strategy, buying a call that you expect to rise and hoping to sell it after it increases in value. In that case, it’s key to pick a call that will react as you expect, since not all calls move significantly even when the underlying stock rises.

Some experienced investors may purchase calls in order to hedge against short sales of stock they’ve made. Investors who sell short hope to profit from a decrease in the stock’s price. If the shares increase in value instead, they can face heavy losses. Buying calls allows short sellers to protect themselves against the unexpected increase, and limit their potential risk.

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Buying call options for different time periods

Buying calls can provide an advantage over several different time periods:

Short term. Investors can profit if they sell an option for more than they paid for it, for example if there is an increase in the stock’s price before expiration.

Medium term. Over a matter of several months, investors can use call options to minimize the risk of owning stock in an uncertain market. Investors who want to lock in a purchase price for a year or longer can buy LEAPS, or periodically purchase new options.

Long term. LEAPS allow investors to purchase calls at a strike price they’re comfortable with, and accumulate the capital to purchase those shares in the intervening time until expiration.

CHOOSING A SECURITY

In general, purchasing calls indicates a bullish sentiment, so you should consider a stock or stock index whose price you think is set to rise. This might be a stock you feel will rise in the short term, allowing you to profit from an increase in premium. You might also look for a stock with long-term growth potential that you’d like to own. Purchasing calls allows you to lock in an acceptable price, at the cost of the premium you pay.

Exercising your call opions

Most call contracts are sold before expiration, allowing their holders to realize a profit if there are gains in the premium. If you’ve purchased a call with the intent of owning the underlying instrument, however, you can exercise your right at any time before expiration, subject to the exercise cut-off policies of your brokerage firm.

However, if you don’t resell and don’t exercise before expiration, you’ll face the loss of all of the premium you paid. If your call is out-of-the-money at expiration, you most likely won’t exercise. If your option is at-the-money, transaction fees may make it not worth exercising. But if your option is in-the-money, you should be careful not to let expiration pass without acting.

Call options vs buying stock on margin

For certain investors, buying calls is an attractive alternative to buying stock on margin. Calls offer the same leverage that you can get from buying on margin, but you take on less potential risk. If you buy stock on margin, you must maintain a certain reserve of cash in your margin account to cover the possible loss in value of those stocks.

If the stock price does fall, you must add cash to meet the margin requirement, liquidate a portion of your position, or face having your brokerage firm liquidate your assets. If you purchase calls, you have the same benefit of low initial investment as the margin trader, but if the value of the stock drops, the main risk you face is loss of the premium, an amount that’s usually much smaller than the initial margin requirement.

The Truth About Buying Call Options by Inna Rosputnia

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