Leveraging Call Options (includes calculator)
An option is a contract that offers the buyer of the contract the right to buy or sell a particular asset (the underlying security) at a specified price. Stock options enable investors to manage risk while seeking profit opportunities, making stock options worth considering for a leveraged investment strategy.
Purchasing “calls” is a popular investment strategy for bullish investors. Call options give the investor the right to buy a stock at a specific price within a specified time frame. If the call option is not exercised within the timeframe of the contract, the option simply expires (historically, about 75% of all options expire without being exercised). Investors who purchase call options are looking to profit from a price increase from the underlying stock.
How You Profit from Call Options
The investor will profit on a call (also known as a “long call”) when the price of the underlying stock rises above the strike price (the agreed-upon price) of the call. The investor who exercises a call ends up with 100 shares (per option) of the underlying stock and has the opportunity to sell the stock and realize a profit.
A stock option is a “wasting asset”, meaning it will expire at the end of the contract. The ownership of a call option cannot be compared to actual ownership of the stock since the option owner does not enjoy the same benefits as a shareholder (e.g. dividends).
This is a simple calculation that asks for your purchase and sale price and the number of months you held the option. The values it returns to you reflect both your net and annualized return.
A Bullish Strategy
Calls are considered to be a “bullish” options trading strategy as they increase in value as the underlying stock price rises. The owner of the call controls the shares for a fraction of the price it would cost to purchase the shares outright. The price of the option is determined by the following factors:
Intrinsic Value- This is the value that the option would have if you were to exercise today. It is the difference between the strike price and the actual current price of the stock.
Time Value- Time value functions as the risk premium the seller collects to offer the option buyer with the right to execute the agreement up until the expiration of the contract. Options that have zero intrinsic value are comprised entirely of time value. The longer the time until expiration of the option the higher the time value.
Extrinsic Value- This is an additional risk factor that accounts for stock volatility.
A good way to look at the leverage potential of options is to calculate for potential profit.
Another good article on call options strategy
________________________________________________________________
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
Recent Posts
- How to Calculate a Stock Market Profit
- Three Basic Financial Concepts for Investors
- Understand an Calculate the Capital Asset Pricing Model (CAPM)
- Calculate Your Retirement Savings Requirements
- The Basics of Stock Market Futures Trading
- How to Calculate Internal Rate of Return (IRR)
- How to Calculate Earnings per Share
- What the Par Value of a Stock Means
- Bond Value Calculator
- Some Basic Forex Trading Tips
Leave a Comment
You must be logged in to post a comment.