A Guide to Buying Call Options

Submitted by Stock Market News on 30 May, 2011 - 16:57

Beginners Guide to Buying Call Options

Once you believe that the share price is on the rise, you will most likely buy a call option. Which one to buy will depend on two main factors that you have to choose, the exercise price and the expiry date. Deciding what expiry date you should settle for and the exercise price you want to lock in involves different factors that you have to look into.

Options: Exercise price

You have to think of what you need to break even. The break even point is derived from subtracting the share price from your premium. You also have to consider how much you are willing to pay for the option. The lower the exercise price, the smaller share price you need to make money. But this can also prove to be expensive, resulting in a bigger lose if the price falls.

Evaluate how bullish you are and how much you are willing to fork over for the premium.

There's no way you can predict what the share price will be at the expiry date. All you can work out is what your profit and loss will be given a share price. At expiry, your option will left with its intrinsic value – the difference share price and exercise price. Then your profit or loss is the difference between the intrinsic value and the premium you paid.

Options: Expiry Month

An option has a limited lifespan, so you target price must be reached before the expiry date. You need an expiry month that will give you enough time to let your expectations play out. A longer term means you have more time for the price to rise. However the longer your expiry months is, the more expensive it becomes. It also makes you more vulnerable to sudden changes in volatility. More importantly, the higher you premium is, the higher your break even point will be, so the share price have to move further for you to profit.

Identify the advantages of each option against the premium and consider the points above. Always remember that the market can move either way, including the exact opposite of what you expect. So make sure you do your own research to cut your loss.