Options Trading - an Overview of Call Options and How You Can Make Money With Them

Understanding how Call Options work and your choices in various scenarios relating to the fluctuation of the related stock prices are the fundamentals of Options Trading. This article gives an overview of Call Options and how you can make money through purchasing and selling Call Options.

A Call Option gives its buyer (holder) the right to buy 100 shares of the underlying security at a fixed price per share, at any time between the purchase of the call and the stipulated date when the option expires. The buyer has a choice and is not obligated to exercise the option. The seller (writer) of the option however, is obligated to sell the shares should the buyer exercise his option.

A buyer of a Call Option takes the position that the stock will appreciate (rise in value) within the effective date of the option, because that will result in a corresponding increase in value for that call. This means that there will be a higher market value in the call, which can be sold and closed at a profit. If not, he can also choose to exercise his option, which means that he buys the stock at a fixed price lower than the current market value.

On the other hand, the seller of a Call Option takes the position that the stock will depreciate (fall in value) within the effective date of the option, because that will result in a corresponding decrease in value for that call. This means that there will be a lower market value in the call. How this benefits the option seller is through the fact that the option buyer will not be willing to exercise his option as he will be paying a higher price than the fixed price in the contract. It will not make logical sense for him to do so as he would be losing money and he may as well exercise his option if he wants to purchase the underlying stock at all.

In such cases, the option buyer is most likely to either sell his option at a loss or move on or wait it out in the hope that the underlying stock price would rise. However, once his option expires, he loses his premium, which is the initial fee he paid to purchase the Call Option.

For a better understanding, let's further go on to illustrate various scenarios relating to the price of the underlying stock and take a look at the choices for action within each. Remember that this is in relation to Call Options.

Scenario 1 - The Market Value of the Underlying Stock Appreciates

In such a scenario, the value for the related Call Option will also appreciate. The buyer of such an option will have two choices. He can either choose to exercise his option and buy the underlying stock at a below current value price, or he can sell his Call Option for a profit.

Scenario 2 - The Market Value of the Underlying Stock Remains Stagnant

In such a scenario, the price of the underlying stock has not seen a change, or the change is too insignificant to create an opportunity for profit. The option buyer has two choices. The first choice he can make is to sell the Call Option before its expiration date. As the price of an option is determined by the remaining time before its expiration, the option buyer will most certainly see a loss if he sells his option without the underlying stock price seeing an appreciation. The magnitude of the loss will depend on how much time is remaining in the option before expiration. The second choice he can make is to hold on to the Call Option in the hope that the stock's market value will appreciate before expiration.

Scenario 3 - The Market Value of the Underlying Stock Depreciates

In such a scenario, the value for the related Call Option will also depreciate. The buyer of such an option will have three choices. He can sell off his option and accept his losses, sit it out in the hope that the stock value will appreciate, or simply let his option expire if his option is already nearing its expiration date.
This article was written by Richard T. Tyler, a veteran with over 20 years of experience in stock trading. Please read his other articles on options trading at Invest Money Stocks for a better understanding of using options as an investment instrument. You can also receive tons of free investment advice here.