Beginner's Guide to Trading Call Options

• Call options give you the right, but not the obligation, to buy a stock at a predetermined "strike" price before an expiration date. You pay a premium for this right.
• If the stock price rises above the strike price before expiration, you can exercise the option to buy shares at below market value and profit on the difference.
• If the stock stays below the strike price, the option expires worthless and you lose the premium paid. The more time until expiration, the more potential for the stock to move.
• Options come in 100-share blocks. Longer expiration dates mean higher premiums but lower risk. Higher strike prices have lower premiums but are less likely to pay off.
• Options trading carries high risk but allows you to profit from stock movements using less capital than buying the stock itself. Understand how options work before trading them.

Options trading may seem complex and risky to novice investors, but learning the basics can unlock significant opportunities to profit. This guide explains what call options are, how they work, and key strategies for trading them successfully.

So What Are Call Options?

A call option gives the holder the right, but not the obligation, to buy shares of a specified stock at a predetermined "strike" price before a set expiration date. Each call option contract covers 100 shares of the underlying stock.

For example, you could buy a call option that allows you to purchase 100 shares of ABC stock for $50 per share anytime until January 1st. This is known as a $50 call option expiring on January 1st.

To acquire this right, you pay an upfront premium to the seller of the call option. This premium will be higher for options on stocks that are more volatile or have longer until expiration.

Why Trade Call Options?

Call options allow you to profit from upside moves in a stock without having to pay the full share price. The predetermined strike price locks in a maximum buy price, while your profits have unlimited upside if the stock rises.

Options enable you to speculate on or hedge against stock movements using less capital than buying the shares outright. You can also generate recurring income by repeatedly selling covered calls against stocks you already own.

However, options have defined expiration dates. If the stock fails to move as expected before expiration, your call option may expire worthless and you lose the premium paid.

How Do Call Option Profits Work?

There are two ways to profit from call options:

Exercise the Option

If the stock price rises above your call option's strike price before expiration, you can exercise the option to buy shares at the lower strike price and immediately sell them at the market price.

For example, if you hold a $50 call option and the stock rises to $60, you can exercise your call to buy 100 shares for $50 each and then immediately sell them for the market price of $60. This nets you a $10 per share profit minus the initial premium paid.

Sell the Option

Instead of exercising the option, you can simply sell it for a profit prior to expiration. If the stock has moved above the strike price, the call option will have increased in value and you can sell it for more than you paid.

Selling your call option avoids having to put up the capital to actually purchase the shares while still realizing profits from the stock's upward move. Options trading doesn't require share ownership.

Minimizing Risk When Buying Calls

While call options offer defined and capped downside risk, you can still lose 100% of your investment if the stock fails to move above the strike price before expiration. Here are some tips to mitigate risk:

• Buy In the Money Options - Choose a strike price below the current stock price so the stock doesn't have to move as much for you to profit. This costs more upfront but has a higher probability of success.
• Go Longer Dated - Give yourself more time to be right by buying calls with at least 3-6 months until expiration. Avoid short-term options of less than 30 days.
• Limit Position Sizes - Don't risk more than 3-5% of your account value on any single trade. Diversify across multiple options contracts on various stocks.
• Use Stop Losses - Set stop loss orders to automatically sell your options if the stock drops below a certain level. This caps potential losses if the trade goes against you.
• Sell Before Expiration - Don't hold options to expiration. Exit winning trades early to lock in profits and cut losing trades quickly before they expire worthless.

Selling Covered Calls for Income

Call options don't just have to be speculative trades. You can sell calls against stocks you already own to earn additional income from your long stock positions through a strategy known as covered call writing.

Here's how it works:

1. You own 100 shares of ABC stock valued at $50 per share.
2. You sell 1 call option contract with a $55 strike price expiring in 3 months for a premium of $2 per share, or $200 total ($2 x 100 shares).
3. For the next 3 months, the buyer of the call option has the right to purchase your 100 shares for $55 each.
4. If ABC remains below $55, the option expires worthless and you pocket the $200 premium as profit on top of any stock gains.
5. If ABC rises above $55, your shares get called away at $55 but you still keep the $200 premium. Your effective sell price is $55 + $2 = $57.

Covered calls limit your upside on the stock but provide downside protection equal to the premium received. It's a conservative options strategy used to generate recurring income from long stock holdings.

Final Tips for Trading Options

Here are some final tips when getting started with options:

• Paper trade first to learn without real money at risk. Platforms like Thinkorswim have virtual trading.
• Closely monitor your positions. Options are complex leveraged instruments and sensitive to stock movements, volatility, and time decay.
• Don't invest money you can't afford to lose. Options can expire worthless. Only risk capital you have set aside for higher-risk trading.
• Read up on options pricing and the Greeks to understand what drives option prices. Knowledge reduces your risk.
• Start small and simple. Master basic call buying before multi-leg strategies and spread trading. Walk before you run.

Options offer advantages for experienced investors but also carry risks. Educate yourself, start slow, and manage positions actively to avoid losses. Master simple call option buying strategies before exploring more advanced options trading.