Congratulations! Youve graduated from Stock Investing University. You now have a firm grasp on buying and selling stocks. But youve heard there’s more to investing than just buying low and selling high—it may be time to consider investing with options. Unlike stocks, options allow you to gain exposure to a stock, whether its on the rise, fall, or even moving sideways. Like a Swiss Army knife, options give you the versatility to persevere during the tough times and prosper during the good times.
Options are more advanced tools that can help investors limit risk, increase income, and plan ahead.
Are you feeling intimidated by call options? Don’t worry – you’re not alone! Many investors think call options always expire worthless, but that’s just not true. I’ve been trading options for years, and I’m here to break down exactly how buying calls works in simple terms.
Call options give you incredible leverage and control over stocks at a fraction of the cost. Whether you’re looking to amplify your portfolio gains or protect against market risks, understanding calls is a valuable skill for any investor
In this guide, I’ll walk you through everything you need to know about buying calls – from basic concepts to practical strategies that can potentially boost your returns. Let’s jump in!
What Exactly Are Call Options?
A call option is basically a contract that gives you the right (but not the obligation) to buy shares of a stock at a specific price (called the strike price) on or before a certain date (the expiration date).
Here’s what makes calls special – they let you control 100 shares of stock for each contract you buy, often at a much lower cost than buying the actual shares.
The main components of a call option include
- Premium: The price you pay to buy the call option
- Strike Price: The price at which you can buy the stock
- Expiration Date: When your option rights expire (typically the third Friday of the month)
- Underlying Stock: The company shares the option is based on
Why Would You Buy Call Options?
There are several good reasons why investors choose to buy calls:
- Leverage: Control more shares with less capital
- Limited Risk: Your maximum loss is just the premium you paid
- Potential for Big Gains: If the stock rises significantly, your percentage returns can be massive
- Flexibility: You can sell the option before expiration to take profits
Most investors buy calls when they’re bullish on a stock – meaning they expect the price to rise. It’s a way to benefit from upward price movements without committing the full amount needed to buy shares outright.
A Real-World Example of Buying Calls
Let me show you how this works with a concrete example
Imagine ABC Company is trading at $50 per share. You’re pretty confident the stock will rise in the next month, but you don’t want to spend $5,000 to buy 100 shares.
Instead, you could buy one call option contract (representing 100 shares) with a $50 strike price that expires in one month for $3 per share, or $300 total ($3 × 100 shares).
Here’s how the two approaches compare:
| Strategy | Initial Investment | Control | Maximum Loss | Breakeven Price |
|---|---|---|---|---|
| Buy 100 Shares | $5,000 | 100 shares | $5,000 (if stock goes to $0) | $50 per share |
| Buy 1 Call Contract | $300 | 100 shares | $300 (limited to premium) | $53 per share |
The breakeven on your call option would be $53 (strike price + premium). If ABC rises above $53 before expiration, you start making a profit!
How to Close a Call Option Position
When you’ve bought a call, you have a couple of choices for closing the position:
1. Sell the Option Back to the Market
Most call buyers never actually exercise their options. Instead, they sell the option back to the market to collect the profit if the option has increased in value.
Continuing our example, let’s say ABC stock rises to $55 near expiration. Your call option would be worth approximately $5 per share (intrinsic value of $55 – $50 strike), or about $500 total. If you sell it, you’d make a $200 profit ($500 – $300 premium).
2. Exercise the Option
You could also exercise the option, which means you’d pay $5,000 ($50 × 100 shares) to buy the shares at your strike price. The shares would be worth $5,500 at the current market price of $55, so after subtracting your original $300 premium, you’d still have a $200 profit.
Most traders prefer selling the option rather than exercising because it’s simpler and doesn’t require additional capital.
Critical Factors to Consider When Buying Call Options
When buying calls, there are several key decisions you need to make:
1. Premium Outlay
This is how much you’re willing to spend on call options. With limited funds, you might need to choose between buying fewer expensive calls or more cheaper ones.
In our example, with $1,500 to invest and calls costing $300 each, you could buy 5 contracts controlling 500 shares – far more than the 30 actual shares you could buy with the same money.
2. Strike Price Selection
The strike price is super important! For calls:
- In-the-money calls (strike below current stock price): More expensive but higher probability of profit
- At-the-money calls (strike equals stock price): Balanced between cost and probability
- Out-of-the-money calls (strike above current stock price): Cheaper but need bigger stock moves to profit
The lower the strike price, the higher the call premium because you’re getting the right to buy at a lower price.
3. Expiration Date
This is another crucial decision. Longer time to expiration means:
- More time for your prediction to play out
- Higher premiums (you pay more)
- Less impact from time decay initially
Shorter expirations are cheaper but give you less time for the stock to move in your favor.
4. Number of Contracts
Once you’ve figured out the strike price and expiration, you need to decide how many contracts to buy. In our example with $1,500 and each call costing $300, you might buy all 5 contracts or perhaps just 3-4 and keep some cash in reserve.
5. Type of Order
Options can be volatile, so you’ll need to decide whether to place a market order (immediate execution at current price) or a limit order (execution only at your specified price or better).
Common Questions About Buying Call Options
What’s the Most I Can Lose When Buying Calls?
The maximum loss is limited to the premium you paid for the call. If the stock never rises above your strike price by expiration, the option expires worthless and you lose your entire premium.
This is actually one of the biggest advantages of buying calls compared to buying stock – your risk is strictly limited!
What Are the Main Drawbacks?
There are a few important challenges to be aware of:
- Time Decay: Options lose value as they approach expiration (called theta decay)
- Need for Precision: You must get both the direction AND timing right
- Premium Costs: Can be expensive for volatile stocks or longer expirations
If the stock doesn’t rise above your strike price before expiration, or if it only does so after expiration, your call will expire worthless.
Should I Exercise My In-The-Money Call Before Expiration?
In most cases, no! Early exercise usually isn’t advisable because you’d lose the remaining time value in the option. It’s almost always better to sell the option instead.
The only time early exercise might make sense is if:
- The option is deeply in-the-money
- It’s very near expiration (so time value is negligible)
- There’s a dividend coming that makes exercise advantageous
Should I Buy Calls on Very Volatile Stocks?
This can be tricky. Highly volatile stocks often have expensive call options due to the implied volatility priced into the premium. While these stocks might make big moves, the high premium creates a higher breakeven point.
If you’re bullish on a volatile stock for the long term, sometimes buying the actual stock makes more sense than buying calls.
My Strategy for Success with Call Options
After trading options for years, here’s what I’ve learned works best:
- Start small – Begin with just 1 or 2 contracts until you understand how they behave
- Focus on liquid options – Choose options with tight bid-ask spreads and high volume
- Give yourself time – I prefer buying calls with at least 60 days until expiration
- Have an exit plan – Decide in advance when you’ll take profits or cut losses
- Watch implied volatility – Try not to buy calls when volatility (and therefore premiums) is unusually high
I’ve found that buying slightly in-the-money calls with 2-3 months of expiration offers a good balance between cost and probability of success.
The Bottom Line on Buying Calls
Call options give you incredible leverage and the ability to control large positions with relatively small amounts of capital. They limit your downside risk while maintaining unlimited upside potential.
Whether you’re a small individual investor or managing a large portfolio, call-buying strategies can be powerful tools to increase your exposure to specific securities and potentially boost your returns.
Just remember – options trading involves more complexity than simply buying stocks. Take the time to thoroughly understand these instruments before diving in with significant capital.
Have you tried trading call options? What strategies have worked best for you? I’d love to hear your experiences in the comments below!
A short call: boosting income
A “short call” is the open obligation to sell shares. The seller of a call with the “short call position” received payment for the call but is obligated to sell shares of the underlying stock at the strike price of the call until the expiration date. A short call is used to create income: The investor earns the premium but has upside risk (if the underlying stock price rises above the strike price).
Both new and seasoned investors will use short calls to boost their income but, more often than not, do so when the call is “covered.” So in case you are assigned, you are simply selling stock that you already own.
An “uncovered” call carries significantly more risk and a potential for unlimited losses because you are obligated to find shares to sell to the call purchaser. Imagine if you had to buy shares which were 20% more expensive than the price you are selling them for. Yikes!
A long call: speculation or planning ahead
A “long call” is a purchased call option with an open right to buy shares. The buyer with the “long call position” paid for the right to buy shares in the underlying stock at the strike price and costs a fraction of the underlying stock price and has upside potential value (if the stock price of the underlying stock increases).
A long call can be used for speculation. For example, take companies that have product launches occurring around the same time every year. You could speculate by purchasing a call if you think the stock price will appreciate after the launch.
A long call can also help you plan ahead. For example, you may have an upcoming bonus that you would like to invest in a stock today, but what if it didnt pay out until the following month? To plan ahead and lock in the price of the stock today, you could purchase a long call with the intent to exercise your right to purchase the shares once you receive your bonus.