The traders buy a call option in future markets or commodities if they expect the underlying future price to move higher. Buying a call option means a buyer of the option has the right to buy the underlying futures price move higher.
A call option is a derivative investment. It is named Call because the owner has the right to sell stock away from the seller. One of the best things of a call option is that you will get unlimited profit and loss is only the amount that you paid for that option.
There are two methods to participate in options by buying an option or writing an option. Entering in this trade you are essentially opening a position sell to open and buy to open. If you are buying an option you must enter buy to open and writing an option you must sell to open the order.
Decide your objectives and then find the best option to buy. You need to consider the following points to keep in mind.
- The time period which you want to spend on the trade.
- An amount you want to allocate to buying a call option
- The length of the move which you expect from the market.
Also Read: Best Definition of Call and Put Options
Most commodities and futures have various options with a different expiry period. It strikes prices what allow you to pick an option that fulfills your requirements.
The time period which you want to spend on the trade
With the help of it, you will know how much time you need for a call option. If you are expecting a commodity to finish its move for more than two weeks, you should select the commodity with at least two weeks of time remaining on it.
In simple words you don’t need to buy an option for 3 to 6 months remaining if you only plan on being in the trade for a week or so. Because the options will be expensive as well as you will lose some leverage as well.
Keep in mind that the time premium of options decays more rapidly in the last 30 days. Although you might be correct in your assumptions about the trade, the option loses too much of the time value that results with a loss.
As per our suggestion, you need to buy an option within 30 more days than you expect to be in the trade.
An amount you want to allocate to buying a call option
This depends on your account size and risk tolerance, some options may be expensive for you to buy and not the right ones as well. The money call options are more expensive than out of the money options.
More the time remaining on calls means more they will cost. Not like future contracts in which there is a margin when you buy most options. You need to pay the option premium up front. The option like crude oil costs a huge amount which may not be suitable for all optional traders.
There is no need to buy deep out of the money options just because they are in your price range. The deep out of the money options will expire worthlessly and are considered long shots.
The length of the move which you expect from the market.
In order to maximize your leverage and control the risk, you need to find which type of move you expect from the commodity/future market. As per the more conservative approach you need to buy multiple contracts of the money options.
Your returns will move higher with multiple contracts of the money options if the market makes a large move higher. At the same time there is a great chance of losing the entire option premium if the market does not move.
Buy call option strategy?
The option is one of the investments that can control more capital with lesser risk. In simple words, it is a speculative play. The option trading strategies can be simple or complex depending on how you make them. Here I am going to mention 5 basic call options strategies.
The long call
This strategy involves buying a call option with a hope the share of underlying stock rises above the strike price before the expiry of the offer. This is extremely simple as like buying an underlying a stock itself. Buying a call provides much higher returns than buying the same amount of the underlying stock that can be riskier.
The covered call
People use this strategy to maximize the potential profits on stocks already in their portfolio covered call strategy. It involves selling call options on a stock which you already own. This strategy is aimed to earn income via premium from the call option. And it also gives benefits when the stock rises. Covered call offers a short-term hedge for the investors who are still bullish a stock.
Bull spread call
Traders utilize bull call spread technique to buy call options at a specific price and expiration date. And sells them simultaneously at the same number of call options for the same date at a higher strike price. The main aim of this strategy is to reduce the overall cost of the trade.
Bear call spread
The bear call spread strategy involves buying call options at a high strike price and selling them at the same number of calls for the same expiration date at a much lower strike price. To initiate the trade the calls sold at a lower strike price to generate more income than the calls purchased at a higher strike price.
Long call butterfly
If you have a specific target for stock and time in mind for a trade, then long call butterfly can be used as call options to make a big bet on stock at relatively low cost. To use this strategy you need to sell two call options with a strike price equals to your target price for the stock. This strategy generates maximum profit if the stock trades to exactly the strike price of the pair of call options initially sold.
Also Read: What is Call Option and Put Option?
Buying a call option example
In a call option, the buyer will get the right, but not the obligation to buy the underlying share or index in the futures. It is but if a trader expects the price of underlying to rise within a certain time frame.
In the stock market, if the stock is trading at $9, it is not worthwhile for the call option buyer to exercise their option to buy that stock at $10 as they can buy it for a lower price in the stock market.
A call buyer has the right to buy the stock at the strike price for a certain period of time. If the price of that underlying moves high above the strike price, the option will have intrinsic value.
The trader can sell the option for a profit or exercise the option at expiry. For these rights, the call buyer needs to pay the premium.
What is the right time to buy a call option?
Time is an important factor when you enter the stock market. Same applies to the derivative market, as you have multiple options there. Now the question arises when do you buy a call option.
In order to maximize the profit you need to buy at the lows and sell at high. A call option fixes the buying price and also indicates you are expecting a possible rise in the price of an underlying asset.
How do calls and puts works?
A call is right to buy and the put is the option to sell the underlying stock at a predetermined strike price until the fixed expiry date. The put buyer has to sell the shares at the strike price if he decides to sell the put is obliged to buy at that price.
How put options work?
There is no market without a buyer or a seller. Same is the case in the options market, you cannot have a call option without having put options. Put options are the contracts that give you the right to sell the underlying stock/Index at a predetermined price on or before the specified period of time or expiry date in the future.
A put option is just opposite to a call option, although they still share some similar traits. Simply taking an example of a call option and put option the strike price and expiry date is predetermined by the stock exchange.
Features of the put options
Fixing the strike price and the amount at which you will buy in the future. Selection of the expiry date and option price.
An amount of the option premium to a broker and broker transfer the same to exchange. The option seller will get the amount through the exchange.
Initial margin, exposure margin and premium
Stock call options and index call options.
The person who buys an option pays you the amount through a broker and the exchange. This helps you reduce the loss or increase the profit.
Features of a call option
To buy a call option the buyer needs to place a buy order with the specific broker with the strike price and expiry date. You also need to specify the amount you are ready to pay for such a call option.
The strike price or exercise price for a call option is the fixed amount at which you agree to buy an underlying asset in the future.
When you buy a call option you need to pay the option writer a premium. This amount is first paid to the exchange, then it passes to the option seller.
You can sell the option by paying the initial margin there is no need to pay the entire sum. Once you pay the exchange you need to maintain the minimum amount in your trading account.
It depends on the underlying asset there are two types of call options, one is Index Option and other is Stock Option. An option can be exercised on the expiry date.
One can sell off the call option to another buyer before its expiry date. By doing this practice you receive a premium, it has bearing on your net profits/losses.
Benefits of buying options?
Investments are considered risk only the traders and experts understands the options can be useful to an individual investor. It is important to look at the advantages offered by options and value to invest in them.
Many investors avoid the options believe them to be sophisticated and hard to understand. Some of them had bad experiences with options due to the brokers were not properly guided them.
The word risky and dangerous have been wrongly attached to the options. It is vital for an individual investor to see both sides of the story before making a decision about the value of options.
The option has great leveraging power, it is similar to a stock position, as well as huge saving. As there is no need to pay the full amount of the stock price, he/she can use the balance amount in his/her discretion. An investor needs to pick the right call to buy.
Buying equity is riskier as compared to buying a call option. Secondly, option needs less financial commitment as compared to equity. Options are a dependable form of hedge and safer than stocks.
A higher rate of returns
There is no need for a calculator to find out if you spend less money to get the same profit. Many investors gained money in the stock market by finding the right stocks poised to make a big move soon.
A call option allows you to employ a variety of income-enhancing and risk-reducing strategies by using different combinations of options. You buy a call option with the strike price near the market price and write a call option at a higher strike price. The premium you receive for the call you, write offsets all or part of the premium you pay for the call you buy.
Call options are the instruments that which can be employed to a position directly in the market to bet the price will appreciate an existing position from an adverse price move.