WHAT IS A CALL OPTION?

There are many vehicles to trade in the markets: stocks, etf’s, futures, currency, and some others. My personal favorite equity to trade is options.

A call option is a contract. Yep, that’s right! A contract that gives the owner the right, but not the obligation, to purchase a set number of shares at a set price. That same contract gives the seller the obligation to sell a set number of shares to you at a set price.

For every one option contract you purchase, you are controlling 100 shares of the underlying. The underlying being any company (stock). I should mention that some futures contracts also can be underlying’s for options… but that is for a different post. We will keep it simple for this one.

So… If you were to purchase one call option contract for company ABC (hypothetical company), you would be controlling 100 shares of company ABC, without having to actually own 100 shares. Now, let’s say that option contract is selling for $1; to purchase the single contract you would have to pay $100 ($1 X 100 shares = $100). The price is just a quote price, it is up to you to determine the full amount. But it’s easy! It’s simply the option price multiplied by 100 shares. If you are buying two option contracts, then it would be the option price multiplied by 200 shares… so on and so forth.

So how do you make money with an option? Well, let’s say company ABC is selling at $10 per share in the open market, and you believe company ABC has a lot of potential and will rise to $12 soon. Instead of having to pay $1000 to own 100 shares of company ABC, you decide to purchase one call option for just $100 (using the $1 option price I discussed above). SWEET! Look at all that capital you freed up in your account to make other investment decisions.

A week later company ABC is selling for $12 in the open market. Awesome! Your analysis was correct and you decide you want to sell your call option to profit. But now, instead of that call option being worth only $1, it is now worth $2.50 (just an example). So you hit that sell button and notice that your profit on the trade was $150. You bought the option for $1 which means you spent $100 for it ($1 X 100 shares), and you sold the option for $2.50 and made $250 profit ($2.50 X 100 shares). Sure, you didn’t make $200 like you could have if you had just bought the shares outright… but consider your percent gain with the option compared to buying the shares outright. Not to mention, consider the amount of money you DIDN’T spend when you bought the option, which allowed you to make other investments.

That’s the basics of a call option. Pretty simple! I should note, however, that options carry with them unique risks, and can be VERY dangerous from a financial standpoint if you do not know what you’re doing. It would benefit you greatly to learn as much as possible about them, before you make your first option play.

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