Buying a Call Option

Although there are various ways in which buying a call option is defined, one of the universally accepted definitions is "an agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity or other instrument at a specified price within a specific time period."

Most people who buy a call option believe that the stock market will surge higher and they can make a profit from the market. The added advantage is that one can exit the option before it expires. All options come with an expiry date, which is set by the stock exchange where it trades. Call options if traded wisely, can reap in enormous profits, but unfortunately the converse of it is also true. Whereas the equity market takes time to depreciate, options can wipe out the earnings rather quickly.

Buying a Call Option : A Few Tips

1. The most important thing to do before you buy call option is to identify the company whose shares you are going to trade in. It is advisable to stick to those companies which have been around for a while and which you are interested in.
2. Once you have decided what stocks you want to invest in, you can then make up your mind whether you want to trade in options for short-term or you want to adopt a long-term approach. It is advisable to go for a 4-6 months time as it gives you time and flexibility.
3. After figuring out the time span for which you want to stay invested, choose the strike price of that stock. For every stock, there are several strike prices available with some offering higher premium or lesser volatility.
4. Once you have come to a decision on the strike price, you can get in touch with your broker to buy the shares.
5. After your broker has helped you make your purchase, you have two options. You can hold on to the contract, which will make you the owner of the stock or otherwise, as soon as the market is bullish, you can sell it off to someone to make profit.

If you do not have a lot of capital to invest in the stock market, buying a call option can be a good alternative. Also, if the market as at a stage wherein your investments are not yielding proper returns, you need to change your stock market trading strategies. Let us take an example to illustrate how buying a call option can help you make profits in a short span of time.

Let us suppose that stock A is trading at $10. If you want to buy 100 shares of A then you will be spending around $1000. Now let us suppose that the stock goes up to $12 in the next six months, you can sell and the total price you will get is $1200, that is in six months time you made a profit of $200 with an investment of $1000.

Think of the other scenario, if you bought a $10 call option with the expiration of six months, it will allow you to have 100 shares but the initial investment would be lesser around $100 - $150. Say, over the next five months the price goes up to $12, you can offset your position and claim a profit. Buying a call option gives you a better return with relatively smaller investments.

This article is just about how call options work, but for buying a call option one needs to have a sound understanding of the stock market. It is very important to understand the basics of stock market investing before you put your money at stake.

The lure of the call options is tempting and many times investors don't act rationally and make decisions in a haste. Stock investing is a skill which comes after years of experience. To quote the legendary investor Warren Buffett, "Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful." So, you should take calculated risks and believe in 'Value investing' while buying a call option and trading stocks.