How to Trade Call Options
Call options are one of the most basic strategies an option trader needs to learn. They are a fundamental trade but one which can be used in a variety of situations. While a basic call option trade may appear simple compared to more advance trading techniques it can be highly profitable when used in the correct scenario. Read on and learn how to implement call options.
Overview of Call Options
Before explaining how to trade calls lets first take a look at what exactly a call option is. Buying a call option gives the owner the right but not the obligation to purchase a financial instrument at a certain price (strike price) and in a specific time frame (expiration date). The seller (known as the “writer”) of the option is obliged to sell the financial instrument to the buyer if demanded.
How to Trade Call Options
Step One: Decide the Direction and Target Price
Call options are a directional trade meaning that you need to predict which direction you believe the underlying financial asset will head. So for example if Coca Cola is currently trading at $39 you need to decide whether you think it will go higher or lower. You should also identify a target price for the underlying asset. So in this example you might decide that Coca Cola will reach $43 a share.
Step Two: Choose the Time frame
The next step is decide within which time frame you think that the option will hit your price target. You might believe that within the next 60 days Coca Cola will be $43 a share or higher.
Step Three: Examine the Options Chain
Inside of your brokerage account select the underlying asset for the option that you want to trade. In our example that would be the common shares for Coca Cola. You can then select the “Options Chains” for that asset. This will show you the expiration dates and prices for all of the call options for that stock. Next select a call option which matches your desired expiration date and strike price. You should also check the open interest and volume for the option that you want to trade. Look for an active market with plenty of volume so that you can get a narrow buy/ask spread.
Step Four: Buy the Call Option
Once you are happy with the call option that you want to buy, either click on the buy button for that option or alternatively telephone your broker to make the trade.
Step Five: Close the Trade
If the call option breaks through the strike price you can choose to exercise the option and sell or keep the shares that you receive. Typically though you will simply sell the call option itself and close out the trade. Before the expiration date you can sell the call option at any time. So provided that the call option heads in the direction that you predicted you can still have a profitable trade even if it doesn’t reach the strike price.
It is important to learn how to master basic trade types like call option trades. Understanding these fundamental trades will give you a framework for how complex options trades are constructed. We will discuss that in future articles. Trading call options can be a very profitable strategy when used correctly.