For beginners who are getting into the business of trading options contracts, or “options,” a few fundamentals involve knowing how these financial instruments work, and how traders use them to access capital gains. Some of the most common tips for buying call options are stated over and over by professionals who want more inexperienced traders to avoid making some of the easiest mistakes regarding this kind of investment. Knowing more about the working of the options market can help investors figure out the best ways to profit from buying call options.
First, traders need to understand the value of options and how to use them. An options contract is a kind of abstract transaction based on fixing a future sale price for a stock. In some ways, this is similar to futures contracts that fix a future delivery price for a commodity. The particulars of call options are a guide to beginners.
What it boils down to is this: the buyer of call options is looking at a designated "strike price." For the option to earn value, the price of the stock has to go above the strike price. This has to happen during the time before the expiration of the option. If the price does not rise above the strike price, the buyer of the call option will lose money up to and including the original value of what he or she purchased. Also, for the buyer to gain from the option, he or she must exercise it during the applicable time period, or in some cases, the buyer could end up with a large amount of actual shares in his or her account.
After securing knowledge about these technical aspects of buying call options, the trader has to know how to pick stocks that will rise in value. There are many ways to do this, whether by trying to time the general market with current events, using earnings information, a 52 week moving average for a stock, or by other means. While it is almost impossible to time the market, and there is a lot of risk in call options, many traders can get good at predicting which stocks will rise within the given time period. One trick is that options are offered by various timelines, so for a greater chance at gain, the trader would buy an option with a longer “time horizon” for that price to rise.
When buying call options, the trader has to calculate value very carefully. Each option has its current price at the time of sale, and the trader will have to choose from a vast menu of priced options. The trader has to calculate a theoretical value, and determine how much he or she stands to gain realistically. The volume of a purchase also factors into this decision; classically, call options are bought in bundles of 100 shares, or one “contract.” Along with the overall market context, pricing options risks correctly will give the trader the best chance of robust gains.
