How To Profit With Call Options

Article Written By: andrelinton

Stock options have been around since the early 1970s. Since then they have shown a compound growth rate of 25% each year. At one point they were only used by professional investors but these days many private investors are using them to their advantage, too. They offer leverage (since 1 option controls 100 shares of stock) and can lead to fast profits (and quick losses). There are two types: puts and calls. We're going to focus on call options.

If you think a stock will go up in value, you could buy a call option. That would give you the right to exercise your call option at any point between today an its expiration. If you did exercise your right then you would pay the strike price per share for the stock the option was written on. You can set the strike price and expiration date to anything you like.

For example, if you buy a "September 21 Cisco call" then you have the right to buy 100 shares of Cisco stock for $21 per share at any time between today and the 3rd Friday in September (options expire on the 3rd Friday).

If you buy a call option and the stock goes up before expiration then chances are you will have some profits. But if the stock only rises a little then you may lose money; depending on how much you paid for the option in the first place. Because of this phenomenon, many investors have chosen instead to sell call options rather than buy them. They are taking advantage of the fact that options lose value as time passes.

The risk is that the underlying stock shoots way up before the option expires. In order to counter that risk, the trader who sold the call option would buy the stock at the same time. That way, if he is called upon to deliver shares after they have gone up in value, he already has them. This is known as a "covered call" investment.

Here's an example covered call. Let's say you own 100 shares of BAC that you paid $14.50 for. You can sell an option that expires three months from now with a strike of 15 for $1. That means you will receive $100 today in exchange for giving up your stock at a price of 15 at any point in the next three months (up to the holder of the option to decide if and when he wants to do that). So, if BAC shoots up to $16 you will have to sell your stock for $15 to the person who bought your option in the beginning. But remember, he paid you $1 at that time, so you really sold your stock for $15 + $1 = $16.

In order to do a covered call strategy well you probably need 100 or more shares of several different companies (for diversification). If you don't have enough money for that then stick to exchange traded funds (ETFs) at the beginning because they remove single-stock risk (since they are baskets of stocks). There are tens of thousands of covered call opportunities at any given time (all combinations of stock, strike, and expiration date).

It will save you a ton of time if you have a covered call screener to help you sort through the possibilities. It's also a good idea to read a few covered call tutorials before you begin investing your real money.

About the Author

The Born To Sell web site is well known for covered call options.

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