What Is A Call Option?
It is a contract between two parties among which one party has the right, but not the duty, to purchase a specific underlying asset at a predetermined price and on a predetermined date in the future.
It is a financial word that refers to a buyer’s ability to acquire stocks, bonds, and commodities at a defined price for a set period.
The call buyer will pay a premium, which will be received by the call seller, in exchange for this right.
Unlike stocks, which can continue to exist indefinitely, an option will cease to exist after it has expired and will either be worthless or have some value.
Call options are classified as derivatives by financial experts since their value is derived from the value of an underlying asset.
Long Call Vs. Covered Call: The Difference
Long Call Strategy
A long call is essentially a call option that bets on the underlying stock increasing in value before the expiration date.
When you buy a long call option, you’re hoping for the stock’s (or other security’s) price to rise so you can profit from your contract by exercising your right to acquire the shares (and usually immediately sell them to rake in the profit).
To be “long a call option,” you must have purchased calls on a specific stock. The call seller holds a short position in the options market.
A long call is a strategy and one of the most frequent options trading strategies.
If you believe the stock price will increase, you should buy a call option as the value of a call grows as the underlying stock price rises.
Read: What Is Option Trading?
When Should You Use A Lengthy Call Option?
If the stock price is greater than the strike price and you own a call option, it makes sense to exercise your call.
You can acquire the stock at a lower price and sell it to the market at a higher price or hang onto it for a long time.
Pros & Cons
- Call options give you leverage, allowing you to make higher percentage adjustments on your capital than you could if you only held shares.
- You can only lose as many as you put in on a long call. As a result, your disadvantage is theoretically restricted.
- As with any form of leverage, what works well for you when you’re right may also work against you.
- When you possess options, you want them to move in your favor as soon as possible after you place the trade. This is due to the time-decay component of options, which means that for each day the stock do not move in your favor, you lose a small amount of money.
- Requires a one-time investment and is ineffective if the market rises just a smidgeon. The market may increase somewhat, but your option will still be to lose money
Risks Associated With Long Calls: Maximum Risk
The risk is restricted to the premium paid plus commissions, and if the call is held to expiration and becomes worthless, a loss of this amount is realized.
Impact Of Stock Price Change Over Long Call
In general, call prices do not fluctuate in lockstep with the underlying stock price. Calls are priced differently depending on their “delta.”
At-the-money calls often have deltas of around 50%, meaning that if the stock price rises or falls by $50, the at-the-money call increases or falls by $50.
Deltas on in-the-money calls are often larger than 50% but not greater than 100%. Deltas for out-of-the-money calls are often less than 50%, but not zero.
Covered Call Strategy
If the option is assigned, selling the call compels you to sell a stock you currently own at strike price A.
After the stock has already witnessed significant gains, some investors will use this method.
They frequently sell out-of-the-money calls, indicating that they are eager to sell the shares and profit if the stock price rises.
In addition to dividends, covered calls can generate revenue on the stock. In that situation, the purpose is to have the options expire worthlessly.
When To Use The Covered Call Option Strategy?
The covered call is best used in neutral or somewhat bullish scenarios where the stock’s future upward potential is limited.
This method is great when the stock you own has a bleak outlook, and it would be wiser to book short-term profits rather than stay holding the stock.
Pros & Cons
Selling covered call options can help mitigate downside risk or increase upside return by exchanging the cash premium for potential upside beyond the strike price + premium during the contract period.
The main disadvantages of a covered call strategy are the risk of losing money if the stock falls in value, as well as the opportunity cost of having the stock “called” away and preceding any significant future gains.
The Risk Associated With Covered Calls
If call sellers don’t hang on to the underlying shares or contracts, they’ll be trading naked calls, which have an unlimited loss potential if the underlying security rises.
As a result, if sellers want to sell shares or contracts, they must purchase back options before they expire, boosting transaction costs while lowering or increasing net gains or losses.
Impact Of Stock Price Change Over Covered Call
If the stock price climbs to the strike price of the covered call that was sold and no higher, the covered call pays out the most.
As the option expires worthless, the investor gains from a minor rise in the stock and collects the entire premium.
If the stock price falls, the call expires OTM, and the quick call’s profit offsets the long stock’s loss, a covered call can compensate to some extent.
The covered call strategy can lose money if the stock decreases more than the call price—often only a fraction of the stock price.
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Frequently Asked Questions
How do I decide which choices to purchase?
Your financial goals will determine the ideal options strategy for you. Before trading in Options, it is good to have a clear exit strategy in mind.
Is it possible to lose money when selling covered calls?
A covered call strategy’s maximum loss is restricted to the asset’s purchase price less the option premium received.
When the ticker changes, what happens to the calls?
A ticker symbol change means nothing to you, the investor, in the broad scheme of things.
What are the benefits of buying a call option?
A call option writer will profit if the underlying stock continues below the strike price.
Amit Gupta is the creator of FreeDematAccount.in, a website that specializes in Demat accounts and provides assistance to all its users in navigating through complicated decisions. After completing his high school certification, Amit spent half a decade learning about Demat accounts from brokerages. Before forming FreeDematAccount.in, Amit worked for a Demat account brokerage.