Call Options: How You Can Trade Them With Examples
What is a Call Option?
A call option is essentially a leveraged play in the stock market.
Opting for a call option over direct stock purchases is a popular method to gain significant exposure to a stock's potential upside, requiring less capital upfront compared to the considerable investment needed to buy the shares outright.
Buying Call Options
When you buy a call option, you're essentially betting on the stock's potential increase in value. You pay a premium for this bet, which is considerably lower than the cost of buying the actual shares.
The catch? The clock is ticking. Every call option has an expiration date, and as it approaches, time decay — or theta decay — eats away at the option's value, which can impact your investment adversely.
Example of Buying a Call Option
Consider the tech giant AAPL. As of the time of writing this, November 8th, 2023, AAPL trades at about $182 per share. An investor bullish on AAPL may purchase a June 2025 call option at a $2.80 premium per share, translating to a $2,800 total premium, as opposed to forking over $18,200 for 100 shares outright.
While the shares themselves can be held indefinitely, potentially accruing dividends, the call option comes with an expiration, making it crucial for the stock to move favorably within a specified timeframe, or the investor risks losing the entire premium paid.
Call Option Example on tastytrade
Calculating the Breakeven of Buying a Call
To figure out your breakeven point on a call option, add the premium paid to the strike price.
Using the AAPL example, adding $2.80 (premium) to $182 (strike price), we arrive at $184.80 — the price per share you’d need to break even if you exercised the option.
Pros and Cons of Buying Calls
The allure of buying call options lies in the reduced capital requirement and the substantial upside potential if the stock price soars. However, the downsides are significant, too — the looming expiration date, the negative effects of theta decay, and the absence of dividends are factors that cannot be ignored.
Buying LEAPs Explained
Long-term Equity Anticipation Securities, or LEAPs, are options with an expiration date well over a year away.
They are a strategic choice for those looking to simulate stock ownership with a call since the longer lifespan mitigates rapid time decay, offering a more gradual investment timeline.
You can also convert a LEAPs option to a poor man’s covered call by selling a closer-dated call option against your LEAPs option.
Selling Call Options
Conversely, selling call options is a strategy where you agree to sell 100 shares at a set strike price, receiving the premium as immediate income.
This approach can be lucrative but comes with its own set of risks and requirements.
Examples of Selling a Call Option
Selling calls can be akin to shorting a stock, where you benefit if the stock price declines.
Yet, there's a stark distinction between naked calls, which require a high-level margin account and entail unlimited risk, and covered calls, which are considerably more conservative and can be executed in most standard brokerage accounts.
Covered Calls Explained
A covered call is a strategy employed when you already own the underlying stock. By selling a call option on these shares, you pocket the premium while agreeing to sell your shares if the stock reaches the strike price.
Covered Call Example
Covered Call Risk Diagram on tastytrade
For instance, if you hold 100 shares of AAPL bought at $180 each, you might sell a covered call with a strike price of $200, earning a $1.00 premium per share.
If the option is exercised, your effective sale price would be $201 per share, considering the premium collected.
Pros and Cons of Selling Covered Calls
Selling covered calls can provide a steady income stream, especially when the underlying stock remains stagnant.
It offers a hedge against downside risk and can be particularly advantageous in retirement accounts where the premium collected can often be tax-free.
How to Learn More About Options Trading
Options trading can be complex and requires a solid understanding of market dynamics.
For those keen to deepen their knowledge, the HaiKhuu Trading Community offers resources and a platform for both novice and seasoned traders to explore strategies and hone their trading skills.
