Call Options: What they are and why some traders use them
Call options offer investors a way to potentially benefit from stock price movements without directly owning the underlying asset. This guide unpacks the essentials of call options — how they work, their advantages and disadvantages, and strategic ways to integrate them into your trading toolkit. Learning how to use call options could help identify potential opportunities tailored to your investment style.
What are call options
A call option is a contract that gives the holder the right, but not the obligation, to buy a stock at a set price (strike price) before or on a certain date (expiration date). If the stock’s price rises above the strike price, the call option could gain value, as it may allow you to purchase the stock below its current market price. You can choose to exercise the option to buy the stock or sell the option itself if it has appreciated. However, if the stock’s price does not rise enough, the option may lose value or even expire worthless, depending on its remaining time and intrinsic value. This gives traders a flexible tool to speculate on price movements or hedge against potential losses.
Why do call options matter
Call options are a useful tool because they let traders control a large quantity of shares with a smaller upfront investment. Instead of buying the stock outright, some investors use options to seek potential gains while managing risk, as they’re only liable for the premium paid. This leverage can enable strategies that might otherwise be prohibitively expensive. For those aiming to enhance potential returns or strategically manage risk, call options add a versatile dimension to many trading strategies — but they can also increase potential losses.
How do call options work
When you buy a call option, you’re paying a premium for the right (but not the obligation) to purchase shares at a predetermined strike price within a specified time period. If the stock price rises above the strike price before the option expires, you can exercise the option and buy the stock at a discount.
However, if the stock price remains below the strike price, the option may expire worthless. In this scenario, where the contract is not exercised, you will only lose the premium paid for the option. This does, however, represent a 100% loss on that trade.
On the other hand, the seller of the call option takes on the obligation to sell the stock at the strike price if the option is exercised, regardless of the stock's market price. Thus, while the buyer's potential loss is limited to the premium, the seller’s risk is theoretically unlimited.
Long vs. short call options
Long and short call options represent different approaches in trading. A long call gives the buyer the right to purchase an asset at a fixed price, when forecasting price increases in the underlying stock. Conversely, a short call commits the seller to provide the asset if exercised, potentially profiting from the premium received from the sale of the call, while expecting prices to remain flat or fall.
Long call strategy
A long call option is primarily a speculative strategy in options trading, allowing investors to forecast an asset's price increase. The theoretical maximum profit is unlimited since the asset's price can rise indefinitely. The theoretical maximum loss, however, is limited to the premium paid for the option assuming the option is not exercised. To break even, the asset's price at expiration must be at least equal to the strike price plus the premium paid. For instance, if a call option has a strike price of $50 and the premium is $5, the breakeven point would be $55. This strategy may be appropriate for investors expecting significant price appreciation while managing risks.
Short call: potential returns
A short call option is a strategy where the seller forecasts against the asset's price increase, aiming to keep the premium collected as profit. The theoretical maximum profit is limited to the premium received for selling the call, as this is the maximum gain if the option expires worthless. However, the theoretical maximum loss is unlimited, as the asset's price can rise indefinitely, leading to potentially unlimited losses if the call is exercised. The breakeven point occurs when the asset's price at expiration equals the strike price plus the premium received. For example, if a call is sold at a strike price of $60 with a $4 premium, the breakeven is $64.
Example of call option strategies
Buying a call option
Imagine you believe Company ABC’s stock, currently at $50, will rise. You decide to purchase a call option with a $55 strike price for a $2 premium, with an option multiplier of 100 (meaning each option contract controls 100 shares).
Option scenario: If ABC’s stock climbs to $60 by expiration, your option allows you to buy the shares at $55. The gain per share would be $60 - $55 = $5. Subtracting the $2 premium, your net profit per share is $3. For one contract (100 shares), your total profit is $300.
Stock purchase scenario: If you instead buy 100 shares at $50, your total investment is $5,000. If the stock rises to $60, you sell for $6,000, earning $1,000.
Comparison: With the call option, you invested only $200 (100 shares x $2 premium) compared to $5,000 for the stock purchase. Your return on the call option ($300 profit on $200 investment) is significantly higher in percentage terms, but if the stock price stays below $55, you lose the $200 premium—this would be your total loss.
Selling a call option
Selling a call option is often employed as part of a covered call strategy, where the seller owns the underlying stock. For example, you own 100 shares of Company XYZ, currently trading at $100 per share, and believe its price will remain stable. You sell a call option at a $110 strike price and collect a $5 premium per share, receiving $500 in total.
If XYZ’s price stays at or below $110 at expiration, the option expires worthless, and you keep the premium as income.
If XYZ’s price rises above $110, you must sell your shares at the strikeprice, limiting upside potential. For example, if the stock rises to $115, you sell at $110, earning $1,500 total (including the premium). However, you miss out on the additional $500 you could have made if the stock were sold at $115.
This strategy allows you to generate income in sideways or modestly bullish markets but caps gains if the stock surges higher.
Uses of call options
Call options are versatile tools that traders and investors use for income generation, speculation, and hedging strategies. One approach is the covered call, where an investor owns the underlying stock and sells call options to generate premium income. For example, selling a $5 call option on a stock trading at $100 generates $500 in income per contract. This strategy works best when stock prices are stable or rise modestly, as investors keep the premium if the stock remains below the strike price. However, upside potential is limited since shares must be sold at the strike price if exceeded.
On the other end of the spectrum is the naked call strategy, where an investor sells a call option without owning the underlying stock. While the goal is to profit from premiums when the stock price stays below the strike price, this strategy carries unlimited loss potential if the stock rises significantly. Naked calls are highly risky and typically reserved for advanced traders.
How to calculate call option potential profit or loss
For long calls, potential profit depends on the stock price exceeding the strike price plus the premium paid upon expiration of the option contract. For instance, if you buy a call option with a $50 strike price and a $5 premium, and the stock rises to $60, your profit is $60 - $50 - $5 = $5 per share. If the stock price is below the strike price at expiration, the option expires worthless, and your maximum loss is limited to the $5 premium.
For call option sellers, the maximum profit is the premium collected. If the stock stays at or below the strike price at expiration, the seller keeps the entire premium. However, if the stock price rises above the strike price, the seller is obligated to provide the stock at the agreed strike price, potentially buying it at a higher market rate to fulfill the contract. This creates a scenario of potentially unlimited losses, as there is no cap on how high the stock price can climb. The seller’s maximum profit is limited to the premium received, while their potential downside can be significant, making this strategy best suited for traders who thoroughly understand market conditions and are comfortable managing risks.
Factors that affect call options price
Several key factors impact call option prices, including the stock's current price, strike price, time to expiration, volatility, interest rates, and dividends. As the stock price approaches or exceeds the strike price, the call option’s value tends to increase. Time to expiration also plays a role: longer timeframes give more opportunities for price movement, exhibited by generally higher premiums. Higher volatility raises option prices, as it suggests a greater chance of profitable movement. Additionally, higher interest rates can elevate call option prices, while expected dividends can lower them, as they often lead to a decrease in the stock price on the ex-dividend date.
How to trade call options on moomoo
Moomoo provides a user-friendly options trading platform. Here's a step-by-step guide to get you started:
Step 1: Navigate to your Watchlist, then select a stock's "Detailed Quotes" page.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 2: Navigate to Options> Chain located at the top of the page.
Step 3: By default, all options with a specific expiration date are shown. For selective viewing of calls or puts, simply tap "Call/Put."
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 4: Adjust the expiration date by choosing your preferred date from the menu.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 5: Easily distinguish between options: white denotes out-of-the-money, and blue indicates in-the-money. Swipe horizontally to access additional option details.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Step 6: Explore various trading strategies at the screen's bottom, offering flexibility for your investment approach.
Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.
Potential pros and cons of call options
Potential pros
Leverage: Options allow you to control a larger position with less capital than buying the underlying asset outright, offering the potential for amplified returns.
Defined risk: When purchasing options, your theoretical maximum loss is limited to the premium you paid for the contract, providing a known and manageable downside.
Flexibility: Options can be used for a variety of strategies, including speculation on price movement, hedging against existing positions, or generating income through covered calls or other strategies.
Potential cons
Expiration risk: If the underlying asset doesn’t move as anticipated by the expiration date, the option may expire worthless, causing you to lose the premium paid. Leverage can also magnify losses, meaning that even small unfavorable movements in the asset's price can lead to significant losses relative to the initial investment.
Complexity: Options involve numerous variables such as strike prices and expirations, making them more complex than traditional stock investing.
Limited time: Since options have set expiration dates, investors face time pressure to achieve their desired outcomes, unlike stocks which can be held indefinitely.
Risk of early assignment (for sold calls): If you sell a call option, you may face early assignment, where the buyer exercises the option before its expiration. This typically happens if the underlying stock's price rises significantly or approaches the strike price, forcing you to deliver the stock or close the position at potentially unfavorable terms.
Long call options vs. long put options
Call options and put options are two basic types of options contracts used in trading. A call option gives the holder the right, but not the obligation, to buy an underlying asset at a predetermined price before the contract expires. Investors typically buy calls when they expect the asset’s price to rise.
A put option, on the other hand, grants the holder the right to sell an underlying asset at a set price within a specific timeframe. Some traders purchase puts when they anticipate a decline in the asset’s price.
FAQ about call options
How can you potentially profit with a long call option?
You can make money on a call option if the stock’s price rises above the strike price by more than the premium you paid, allowing you to sell the option for a profit or exercise it to buy the stock at a discount.
Are call options better than stocks?
Call options offer leverage and lower upfront costs, but they expire, which adds time risk. Stocks, on the other hand, don’t expire and can be held indefinitely. It depends on your level of experience, goals, and risk tolerance.
Why do some people buy options instead of stocks?
Options generally allow traders to gain exposure to a stock’s price movement with less capital than buying the stock outright. They also provide flexible strategies for speculation, income, and hedging.
What's your profit on buying or selling an option?
Your potential profit on buying a call option varies throughout the life of the option, not just at expiration. It depends on how much the stock price exceeds the strike price, minus the premium paid. As the stock price rises, the value of your option can increase, giving you the choice to sell it before expiration for a profit.
For selling a call option, your potential profit is the premium received, but if the stock price rises beyond the strike price, any gain is reduced by the cost to buy back the option or the loss from the stock price exceeding the strike price. You can close the position before expiration to manage profit or limit potential losses. You can also choose to maintain your short call position through expiration but risk assignment.