Call Options Tutorial

In this video, Rebecca, from Zecco Sirens, is trying to teach us the basics and talks about the simplest of all options trades: the purchasing of a call option. The Wall Street guys want to make us think that it is very complicated, so you can pay them fat commissions to do it for you. She will show that anyone can understand a call option. Using call option, you will have the right to purchase a stock at a specific price. That price is called the strike price.

So, if you think that the price of the stock is going to go up, but you want to get him with a minimal investment, you potentially can get more upside than less money down. If the underline stock goes up, your gain is unlimited. Even if the underline stock goes down to zero, you will never lose more than the amount you paid for the option.

Call Option Example

Here is an example. You find a nice stock, and you want to buy it with the call option. That means that you are buying with the strike price, at or near the current stock price. Let's say this stock is trading at $10 a share. You can buy 100 shares of that stock for a total investment of $1,000. Let's say this stock goes up $2, to $12. You are making a 20% return or $200. But let's say that you don't want to invest $1,000.

You can buy a single call option which gives you the right to buy 100 shares of that same of stock, at the strike price of $10 a share sometime in the future. Let's say the option is priced at $1, you multiply this with 100 to get the cost of the trade. Since each option controls 100 shares of stock. In this case, the cost is $100 plus commissions. Now you have the right to buy 100 shares of stock at $10. Now, let's say again that the stock goes up to $12. You can get the $200, but minus the original $100 dollar investment. So you have now $100. And since you only invested $100 in the beginning you are at zero.

Why can this be a good trade? For three reasons:

  1. It is easy to trade. You only need to trade a single call option to execute it
  2. You have limited loss. You can never lose more than the amount that you paid for a call option
  3. It is a leveraged trade. If you are writing your prediction about the movement of the stock in the short-term, your return can be substantially relative with the amount of money that you risked on that trade
Submitted by YouTube Trader on Thu, 04/08/2010 - 12:43

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