What Are Call Options and How Do They Work?
A call option is an options contract that grants its buyer the right (but not the obligation) to buy a specific quantity (usually 100 shares) of an asset (like a stock) at a specific price on or before the date of the contract’s expiration.
In exchange for this right, the option buyer pays the option seller a premium. A call option is considered a derivative security because its value is derived from the value of an underlying asset (e.g., 100 shares of a stock). Investing in a call is like betting that the price of a stock will go up before the call contract expires. In other words, calls are typically bullish investments.
Call Options vs. Put Options
Call options are the opposite of put options. While calls give their owners the right to buy something at a specific strike price, puts give their owners the right to sell something at a specific strike price.
A call investor bets on the value of a security going up (which would allow them to buy shares for less than they’re worth or sell the contract for more than they paid), while a put investor bets on the value of a security going down (which would allow them to sell shares for more than they’re worth or sell the contract for more than they paid).
How Can You Make Money on a Call Option?
Investors can realize gains from call options in one of two ways—reselling or exercising.
Every option has a premium (current market value) for which it can be bought and sold, and this premium changes over time based on factors like the contract’s intrinsic value (the difference between the strike price of the contract and the market price of the underlying asset), time remaining until expiration, and the volatility of the underlying asset.
To make a profit, an options trader could buy a call option for a security they believe will go up in value. If this occurs, the option’s premium will increase, and the contract holder can resell the option for its new, higher premium, pocketing the difference between what they sold it for and what they bought it for.
Alternatively, an investor could purchase a call option contract with a strike price equal to an underlying security’s market price in the hopes that the security will gain value before the contract expires. If the underlying security does go up in price, the option holder can exercise the option and buy shares at the strike price, which is lower than the new market price of the underlying asset. Their profit here is the security’s market price minus the call option’s strike price times 100 shares, minus the premium they paid for the contract.
It’s important to remember here that the premium an investor pays for a contract is part of their cost basis and should be factored in when deciding when to sell or exercise an option for profit. Options investors only make a profit if their gains exceed the premium they paid for the options contract in question.
Why Do Investors Buy Call Options?
Many investors find call options attractive because they don’t require a large amount of up-front capital. This is because calls allow a trader to profit off the upward price movement of a stock (in chunks of 100 shares) without actually purchasing the shares themselves.
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Additionally, risk is limited, as the most an option buyer stands to lose is the premium or cost of the options contract itself—not the total value of the underlying shares.
In essence, call options allow bullish traders to bet on price appreciation without having to purchase real shares, which requires more capital and comes with more risk.
How Can You Tell if a Call Option Is in the Money (ITM) or Out of the Money (OTM)?
Options that have intrinsic value are considered “in the money,” whereas options that don’t are considered “out of the money.” A call option is in the money and has intrinsic value if its strike price is lower than the market price of the underlying asset (this is also called the spot price).
For example, a call option with a strike price of $50 and a spot price of $60 would be in the money by $10 because if it was exercised immediately, shares could be bought for a $10 discount. In other words, this particular call contract would have $10 worth of intrinsic value because it grants its owner the right to buy shares of stock for $10 less than what they’re worth.
Intrinsic value is always included in an option’s premium, so there would be no point in buying an in-the-money call just to exercise it right away, as its premium would incorporate its intrinsic value, so no gains would be realized. If an investor purchased the theoretical call option discussed above, they would do so in the hope that the underlying asset would continue to fall in price, causing the option’s intrinsic value to exceed the premium they paid for it before exercising or reselling the contract.
If a call option’s strike price was greater than its spot price, it would be considered out of the money because it would lack intrinsic value. In other words, there would be no point in exercising an OTM call because if you did, you’d be buying shares for more than they cost on the open market.
How to Trade Call Options
Options like calls can be traded via most popular trading platforms like Charles Schwabb, Robinhood, WeBull, and Fidelity. Typically, however, investors must apply for approval from their brokerage before beginning to trade options. Options can also be traded directly—not through a broker—on the over-the-counter (OTC) market.
2 Common Call-Trading Strategies
There are many ways to trade calls, but the following three strategies are among the most common.
1. Long Call
A long call is the most straightforward call-trading strategy. If an investor is bullish on a stock (i.e., they think it will go up in value), they can buy a call option on it. If they choose an option whose strike price is at or above the underlying asset’s market price (i.e., one that is out of the money), there will be no intrinsic value included in the contract’s premium.
If the stock in question goes up in value before the contract expires, the option might gain intrinsic value by moving into the money, and the investor could then either resell it for a profit or exercise it in order to buy shares of the underlying stock for less than they’re worth.
An investor might time a long put such that its expiration occurs some time after an event that they think will impact the underlying stock’s price, like an earnings report or the closing of an acquisition. If their prediction is wrong, and the news causes the stock to fall, the most they stand to lose is the premium they paid for the contract. If, on the other hand, their prediction is correct, their profit simply depends on how much the stock goes up in price.
2. Covered Call
Covered calls are usually written by investors who are long on a stock (i.e., they own it and don’t plan to sell it in the near future) but don’t think it will go up significantly in price in the short term. An investor like this would write a one call option for every 100 shares of the stock they own with a strike price similar to the stock’s current market price. This means that if the price of the stock falls, the options would expire worthless and the investor who wrote the call would get to pocket the premium.
If, however, the stock in question did go up significantly in value before the contract’s expiration, the buyer of the call option would be entitled to purchase the seller’s shares below market value. Fortunately, the seller would not have to buy these shares at their new higher price in order to sell them for a loss since they already owned them. This would not be an ideal situation for the option seller, as they would have missed out on the gains they would have realized had they simply continued to hold their initial long position in the underlying stock.