What Are Call Options?

Keep reading to learn more about what are call options.

Updated: June 13, 2024
Matt Crabtree

Written By

Matt Crabtree

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In the world of investments, there are a lot of great options. Your portfolio is meant to be significant to you. But in order to make it so, you first need to understand your options. Some investment choices require skill and monitoring to truly understand. 

Call options are one such investment. These are more advanced, but they ultimately can help increase your income and potentially limit the risk of your investments as well. 

Keep reading to learn more about what are call options, and learn how to put them to work for you on your trading platform. 

What Are Call Options Exactly?

Much like any other investment, a call option is a type of financial contract. Ultimately, call options offer you the right to buy a stock, but it doesn’t require you to do so. You can use call options against commodities, stocks, bonds, etc. 

Your call option ultimately allows you to buy a stock, or underlying asset, at a specific price, if the asset reaches that price within a specified time period. If you change your mind when the price point hits, that’s ok. And if it never hits that point, then you simply never buy the asset. 

Here’s a great example. You really want to purchase Apple shares, but your target price is £150. Placing a call option against this stock for £150 will target that, and give you the option to buy should it hit that price in your timeframe. 

Some people use call options when they expect a stock to drop in price, so that they can capture it at a low point. 

The benefit is that you are guaranteed that stock at that price, if you choose to execute it. You simply pay whatever trading fees are required on your platform. 

Short Calls & Long Calls: What’s the Difference

Now, you understand the basics of a call option, but what about the different types of call options and how to use them? When you’re trading call options, you can trade either short or long calls. These are very different, and used for different reasons too. 

When you hear about calls like what we described above, they are almost always long calls. You choose your strike price (the target price), and then you have the right to buy if the price is reached. It’s almost like budgeting for that stock or asset. 

Long calls are often referred to as planning ahead, or perhaps speculating. But you have no obligation to purchase the stock, even if it hits the target. 

Short call options are income creators. These are best for covered calls to prevent or limit the risk and potential loss. A short call is an obligation to sell shares if they reach a specific strike price within the date terms. The downside to short calls is the risk potential of paying substantially more. 

Understanding How Call Options Work

The main points of using call options works within three realms. 

  • Underlying asset
  • Strike price
  • Expiration date

You’ve seen us mention these things above, but let’s break it down a bit more. 

The underlying asset is the stock, bond, commodity, or other applicable investment that you are placing the call option against. You will also need to choose how many shares for the underlying asset. The most common is 100, but that is not always the case. 

From there, you choose your strike point. If you use an investment advisor, they might also be able to help with your decision. This strike point is the price at which you want to have the right to purchase the asset. 

Finally, every call option will have an expiration date. They are not infinite, so the expiration date sets a timeframe for the stock to reach the strike price and grants you the opportunity to execute your call. 

Once the call option is in place, your systems will watch for these targets and alert you in most cases. Then, you have the ability to pull the plug should the pricing happen. Be sure to check your platform for the exact details of how it works there. 

Now, the last part is the fee you will pay for using call options. This fee will vary by platform and the call option in mind, but just be aware you will likely have some sort of associated fee. 

How to Make Money on Call Options

Call options can be used to make money when you plot them right. Of course, you never know exactly what the market will do, but you might have some speculations. That’s exactly what call options are about. 

There are two calculations to be familiar with in terms of making a profit or breaking even. But in terms of income, we’re mostly concerned about the profit calculation, right? 

To calculate profit on buying call options, you would simply take the payoff minus the premium paid. And the payoff is calculated by subtracting the strike price from the current price. 

These calculations are the opposite for selling call options. The profit is the payoff plus the premium, while the payoff remains the current price minus strike price. 

Most traders use call options for income by purchasing the stock at a low price, and then selling the stock at a higher price. Their income then is the difference from their purchase price and sale price. Call options simply put a target on that price, and let you be in control of the buying and selling details. 

Don’t forget to consider the premium you might pay, as well as any fees, when you are calculating your profit based on these numbers. 

Using Call Options to Their Full Potential

While call options are often used for investment income, it’s really proper execution and understanding of how to use them that makes that happen. There are three primary uses of a call option, and the approach varies with each of these. 

  • Income
  • Speculation
  • Tax Management

We’ve focused heavily on income in this guide. For income potential, using a covered call works to your advantage the most. You own the stock, you create a call option, and you wait for the market to do its thing so you can make a profit. Your income might be limited by a ceiling when there is a major rise in price. 

Next is speculation. This is designed for someone who thinks they know where the market, or a specific asset, is headed. It enables that buyer to get in at a good spot, and do so at a low cost. If the speculation never comes to fruition, they could potentially lose their premium. However, that should be their only loss in this scenario. 

Finally, tax management is another use for call options. The benefit is to manage the capital gains, or in some cases even offset them to reduce your tax liabilities. However, what you should be aware of is how long the holding periods are in order to avoid short-term capital gains that can sometimes have larger tax liabilities. 

Exercising a Call

As we wrap up this guide, let’s talk about exercising that call option. There are many call options that are never exercised. Remember that these are long-term “watchers” in a sense. 

There will be the need to monitor the underlying asset for it to hit that strike price you selected. You choose whether or not to exercise when the price reaches a place that is advantageous for you. Which direction is advantageous is solely dependent upon whether you’re looking at a long call or a short call

When the timing is perfect and the price is where you want it to be, you have the right to then execute your call option and take advantage of the price in the market. 

Final Thoughts

Call options are nothing new. If anything, they are quite possibly used less now than ever before. This stems back to a lack of understanding as to just how they work. While there can be some risk to them, if you know the right approach, you are far more likely to see success. 

The nice thing is that you don’t have to constantly stalk the market for the price you want to hit on an asset. Call options do this for you. You just need to know what your targets are, and the timeframe you’re willing to wait for them to hit there.

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