Summary: The simplest option strategy is the long call, which will allow you to capitalize on a rise in the price of the underlying asset
What is it and why would you want to buy this?
A purchased call option gives the right to buy an underlying asset (a share, for example) for a certain amount during a certain time. Suppose you expect a certain stock to rise. You could either buy the share itself, or you could buy an option – for much less money than a direct investment in the share – which gives you the right to buy the shares. So instead of buying the shares themselves, you buy the right to buy the shares! One option contract is valid for 100 shares, so prices will always have to be multiplied by 100.
This right has a certain timeframe or term that can vary from a few days to a few years. It’s important to understand that an option with a longer term is more expensive than an option with a shorter one. After all, the chance that the underlying value will rise is greater the longer the term. The maturity of normal options is typically on the third Friday of the expiry month. The only exception to this are the daily and weekly options.
The key thing you also want to know in advance is the price at which you can buy the shares This is called the “strike price” of the option. The strike price of an option determines the price at which the share may be bought.
Example:
Let's take a look at the APPL stock. The share is currently trading around $145. You can buy the shares yourself but you can also buy a call option on it that runs until, let’s say the third Friday of March 2022. There are different strike prices but I would like to look at the call with a strike price of €160. If you want to buy this option, you have to pay $5.35 for it.
What does this mean?
If you were to buy this call, you have the right – and not the obligation – to buy the Apple shares for $160. This right runs until the third Friday in March 2022
When are you happy with this right?
If the share is going to rise above €160, because then this purchase right is worth money! What would it be worth if, for example, the stock were trading at $180?
The call gives the right to buy the share for $160 while it trades on the stock exchange for $180. This means that the purchase right on $160 must be worth at least $20! Then the call you bought for $5.35 would have become worth $20!
When are you not happy?
If the stock goes down. Because if, for example, the share is listed at $130 on the expiry date, the right to buy it $160 is not interesting. After all, you can buy it on the exchange.
When do you buy a call?
You buy a call if you think the underlying asset will rise in the coming period.
When will you sell the purchased call?
Once you've bought a call, you don't have to stay in it until the end of the term. You can also sell this call at any time during the trading day. So you could buy a call on Monday and sell it again on Wednesday.
When you take profits depends on your view of the underlying asset. If you think that the underlying value can rise further, you don’t have to say goodbye just yet. You can also choose a target, for example, a doubling of the option price. Once this is achieved, you sell. It is also wise to determine in advance when you will sell in the event of a loss. For example, you could follow a rule that if you lose 50% of the value, then you sell the option. You can also choose to lose the entire option premium because you know that the loss can never be greater than the premium paid.
What is your maximum risk?
The risk you run when buying the call is the premium you have paid. That is your maximum loss. This will occur if the stock remains below the strike price you bought. You can therefore never lose more than the option premium that you have paid.
In short
You buy a call if you think the underlying asset is going to rise. Your maximum risk is also known in advance and that is the price you paid for the call option. That’s the maximum amount you can lose.
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