Buying call options | Fidelity (2024)

Call options grant you the right to control stock at a fraction of the full price.

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Buying call options | Fidelity (1)

Key takeaways

  • Like stocks, options are financial securities.
  • There are 2 types of options: calls and puts.
  • Calls grant you the right but not the obligation to buy stock.

If you are bullish about a stock, buying calls versus buying the stock lets you control the same amount of shares with less money. If the stock does rise, your percentage gains may be much higher than if you simply bought and sold the stock.

Of course, there are unique risks associated with trading options. Read on to see whether buying calls may be an appropriate strategy for you.

The basics of call options

The buyer of call options has the right, but not the obligation, to buy an underlying security at a specified strike price. That may seem like a lot of stock market jargon, but all it means is that if you were to buy call options on XYZ stock, for example, you would have the right to buy XYZ stock at an agreed-upon price before a specific date.

The primary reason you might choose to buy a call option, as opposed to simply buying a stock, is that options enable you to control the same amount of stock with less money.

For instance, if you had $5,000, you could buy 100 shares of a stock trading at $50 per share (excluding trading costs), or you could purchase call options that grant you the right to buy the same amount of shares for significantly less, as we’ll demonstrate shortly.

Buying call options | Fidelity (2)

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The characteristics of call options

Compared with buying stock, buying call options requires a little more work. Knowing how options work is crucial to understanding whether buying calls is an appropriate strategy for you. There are several decisions that must be made before buying options. These include:

  • The security on which to buy call options. Suppose you think XYZ Company stock is going to rise over a specific period of time. You might consider buying XYZ call options.
  • The trade amount that can be supported. This is the maximum amount of money you would like to use to buy call options.
  • The number of options contracts to buy. Each options contract controls 100 shares of the underlying stock. Buying three call options contracts, for example, grants the owner the right, but not the obligation, to buy 300 shares (3 x 100 = 300).
  • The strike price. This is the price at which the owner of options can buy the underlying security when the option is exercised. For instance, XYZ 50 call options grants the owner the right to buy XYZ stock at $50, regardless of what the current market price is. In this case, $50 is the strike price (this is also known as the exercise price).
  • The price to pay for the options. Whereas you buy the stock for the stock price, options are bought for what’s known as the premium. This is the price that it costs to buy options. Using our 50 XYZ call options example, the premium might be $3 per contract. So, the total cost of buying one XYZ 50 call option contract would be $300 ($3 premium per contract x 100 shares that the options control x 1 total contract = $300). If the premium were $4 per contract, instead of $3, the total cost of buying three contracts would be $1,200 ($4 per contract x 100 shares that the options control x 3 total contracts = $1,200).
  • The expiration month. Options do not last indefinitely; they have an expiration date. If the stock closes below the strike price and a call option has not been exercised by the expiration date, it expires worthless and the buyer no longer has the right to buy the underlying asset and the buyer loses the premium he or she paid for the option. Most stocks have options contracts that last up to nine months. Traditional options contracts typically expire on the third Friday of each month.
  • The type of order. Like stocks, options prices are constantly changing. Consequently, you can choose the type of trading order with which to purchase an options contract. There are several types of orders, including market, limit, stop-loss, stop-limit, trailing-stop-loss, and trailing-stop-limit.

Options enable leverage

There’s an important point to note about the price you pay for options. Notice how buying one contract would cost $300, and this would grant the owner of the call options the right (but not the obligation) to buy 100 shares of XYZ Company at $50 a share.

Now, compare that with the cost of buying the stock, rather than buying the call options. To purchase 100 shares of XYZ Company, you would need to pay $5,000 ($50 per share x 100 shares). This illustrates the primary purpose of options. They effectively allow you to control more shares at a fraction of the price. That’s leverage at work.

Of course, once you exercise the options, you have to pay for the stock at the strike price—$50 in this case. But you would do so only if the stock price had risen high enough for the option to be in the money—a term that implies an option is worth exercising because the stock price is above the option’s strike price. The ultimate goal is for the stock price to rise high enough so that it is in the money and it covers the cost of purchasing the options.

Advantages and disadvantages

In addition to being able to control the same amount of shares with less money, a benefit of buying a call option versus purchasing 100 shares is that the maximum loss is lower. Plus, you know the maximum risk of the trade at the outset.

The maximum risk of buying $5,000 worth of shares is theoretically the entire $5,000, because, while it is unlikely, the stock could go to zero. In our example, the maximum risk of buying one call options contract (which grants you the right to control 100 shares) is $300. The risk of buying the call options in our example, as opposed to simply buying the stock, is that you could lose the $300 you paid for the call options.

If the stock decreased in value and you were not able to exercise the call options to buy the stock, you would obviously not own the shares as you wanted to. Alternatively, if you simply bought the stock at $50 per share, you would own it right away, rather than having to wait on exercising the call options to potentially own the shares.

Another disadvantage of buying options is that they lose value over time because there is an expiration date. Stocks do not have an expiration date. Also, the owner of a stock receives dividends, whereas the owners of call options do not receive dividends.

Potential profit/loss

Before making any trade, it’s extremely helpful to know the maximum potential profit or loss you can incur. This is particularly true for options trades.

The maximum potential profit for buying calls is the same profit potential as buying stock: it is theoretically unlimited. The reason is that a stock can rise indefinitely, and so, too, can the value of an option.

Conversely, the maximum potential loss is the premium paid to purchase the call options. If the underlying stock declines below the strike price at expiration, purchased call options expire worthless. Recalling our previous example, the maximum potential loss for buying one call options contract with a $3 premium is $300. If the stock does not rise above the strike price before the expiration date, your purchased options expire worthless and the trade is over.

How you make an options trade

You must first qualify to trade options with your brokerage account. At Fidelity, this requires completing an options application which asks questions about your financial situation and investing experience, and reading and signing an options agreement. Assuming you have signed an options trading agreement, the process of buying options is similar to buying stock, with a few differences.

You would begin by accessing your brokerage account and selecting a stock for which you want to trade options. Once you have selected a stock, you would go to the options chain. An options chain is where all options contracts are listed.

After you’ve selected the specific options contract that you’d like to trade, an options trade ticket is opened and you would enter a buy to open order to buy call options. Then you would make the appropriate selections (type of option, order type, number of options, and expiration month) to place the order.

With the knowledge of how to buy options, you can consider implementing other options trading strategies. Buying call options is essential to a number of other more advanced strategies, such as spreads, straddles, and condors. Once you master buying calls, the world of options opens up.

Buying call options | Fidelity (2024)

FAQs

Are buying call options worth it? ›

Call options give buyers the right, but not the obligation, to buy a stock for a fixed price, on or before some date. Buying call options on a stock can be more profitable — but also more risky in percentage-change terms — than buying that stock itself. Selling (or "writing") call options can generate income.

What is the downside of buying call options? ›

Another disadvantage of buying options is that they lose value over time because there is an expiration date. Stocks do not have an expiration date. Also, the owner of a stock receives dividends, whereas the owners of call options do not receive dividends.

Can you make money buying call options? ›

Buying (going long) a call is among the most basic option strategies. It is a relatively low-risk strategy since the maximum loss is restricted to the premium paid to buy the call, while the maximum reward is potentially limitless. However, the odds of the trade being very profitable are typically fairly low.

What is the most you can lose buying a call option? ›

Although Options are important tools for hedging and risk management, traders could end up losing more than the cost of the option itself. Below is a summary of how options function. As a call Buyer, your maximum loss is the premium already paid for buying the call option.

How long should you buy call options? ›

In general, 30-90 days is the “sweet spot” for most options trading strategies. If you're correct and the price of the underlying goes exactly where you expected, you're rewarded with quick profits. If the position doesn't work, you don't have to wait until expiration.

Why would someone buy a call option? ›

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 didn't pay out until the following month?

Why option buying is not profitable? ›

As options approach their expiration date, they lose value due to time decay (theta). The closer an option is to expiration, the faster its time value erodes. If the underlying asset's price doesn't move in the desired direction quickly enough, options buyers can suffer losses as the time value diminishes.

Who should not trade options? ›

Who might not want to consider trading options? Buy and hold investors. Individual investors whose investing plan involves buying stocks, bonds, and other investments with a multiyear time horizon may not typically consider trading options (although there can be circ*mstances where it may be appropriate).

Why option buying is better than selling? ›

Buying options involves the risk of losing the initial premium but offers the potential for unlimited gains. Selling options can generate immediate income but exposes the seller to potentially unlimited losses.

Can options make you a millionaire? ›

You might very well have the patience and diligence to get rich with options. It will probably take you years to accomplish, but with dedication and effort it is entirely possible to make a lot of money with options on top of your long-term investing.

How did one trader make $2.4 million in 28 minutes? ›

For one trader, the news event allowed for incredible profits in a very short amount of time. At 3:32:38 p.m. ET, a Dow Jones headline crossed the newswire reporting that Intel was in talks to buy Altera. Within the same second, a trader jumped into the options market and aggressively bought calls.

Why buy options instead of stocks? ›

Options can be a better choice when you want to limit risk to a certain amount. Options can allow you to earn a stock-like return while investing less money, so they can be a way to limit your risk within certain bounds. Options can be a useful strategy when you're an advanced investor.

How do you never lose in option trading? ›

The option sellers stand a greater risk of losses when there is heavy movement in the market. So, if you have sold options, then always try to hedge your position to avoid such losses. For example, if you have sold at the money calls/puts, then try to buy far out of the money calls/puts to hedge your position.

What is the 3 30 formula? ›

The 3-30 rule in the stock market suggests that a stock's price tends to move in cycles, with the first 3 days after a major event often showing the most significant price change.

How much money do you need to buy a call option? ›

The purchase of call options involves a premium amount for completing the trading transaction. If the premium is $2 per share and the call option is for 100 shares at $60, the investor would pay a $200 premium for this transaction.

Is it better to buy call options in-the-money or out of the money? ›

Out-of-the-money options perform better with a substantial increase in the price of the underlying stock; however, if you expect a smaller increase, at-the-money or in-the-money options are your best choices. Bullish investors must have a good idea of when the stock will hit their target price—the time horizon.

Is call option profitable? ›

Selling Call Options

They profit by pocketing the premiums (price) they are paid. If the option buyer exercises their own option profitably while the underlying security price increases over the option strike price, their profit will be diminished, and they may even lose money.

Is it better to buy options or sell options? ›

Buying options involves the risk of losing the initial premium but offers the potential for unlimited gains. Selling options can generate immediate income but exposes the seller to potentially unlimited losses. If sellers also buy other options to make spreads, it will limit both their upside and their downside.

Is it a good idea to buy options? ›

Options can be very useful as a source of leverage and risk hedging. For example, a bullish investor who wishes to invest $1,000 in a company could potentially earn a far greater return by purchasing $1,000 worth of call options on that firm, as compared to buying $1,000 of that company's shares.

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