What is a Call Option in Options Trading and How Does It Work?

Options are unique financial instruments that traders use to hedge their existing trades. On top of that, trading these financial instruments can also be profitable, but first, you must understand how to trade calls.

These contracts offer a trader an option to sell or purchase depending on whether it’s a call or put option. But in our stock calls explained article, we’ll elaborate more on what is a call in options trading. We’ll also answer the question, “What is a short call vs long call?”

Understanding the Concept of Call Options in Trading

What is a call in options trading? Well, call options are contracts between a seller and buyer to purchase a financial asset at a particular price and on a set date. These contracts grant the buyer the right but not the obligation to purchase the asset.

The specified price refers to the set strike price. A call option’s expiration date is the time/day when it expires.

When you purchase a call option, you pay a premium which is the maximum anyone can lose. If the price is below the strike price when it expires, then you’ll lose your premium.

Exploring the Role of Call Options in Options Trading

Now that we know what is call in options trading? We need to find out its role in options trading. Generally, call options are the opposite of put options. Call options can become more valuable when the price of the stocks increases.

Investors use calls to change portfolio allocation without selling or purchasing financial assets. Traders use call options when they don’t want to trigger a taxable event. And the only way they’ll have to provide the stock is if the price remains above the strike price on the expiration date.

On top of that, traders can exercise the option before the expiration date. But if its price is lower than the strike price, you’ll end up losing your premium.

Key Characteristics and Benefits of Trading Call Options

Call options’ payoffs refer to the loss or profit that sellers or buyers make when trading these financial assets. Calls grant you a right but not an obligation to purchase a security when it expires. Some of the key benefits of trading options include:

  • Hedging: You can use call options to lower the losses you may incur from existing trades.
  • Low capital requirement: Since you’re not required to purchase the stocks, you’ll only pay the premium, which can be quite low.
  • Options give you the right to leverage: Which means you can earn more when the market goes your way.
  • You can combine options with stock trading: With proper practice, you can create a new stream of cash every month. Luckily, there are several tools and indicators that you can use when trading call options.

How to Execute Trades With Call Options

When buying call options, you only need to pay the premium and set the strike price and date. Remember, it’s upon the owner to exercise the option of letting it expire if it’s unprofitable. Calls are considered in the money if their price exceeds the strike price.

So if you purchase a call for $1.50 with a strike price of $15 and its price at expiration is $20. Then the option will be worth $5 while your profit will be $4.50 ($5 minus $1.50). But if it’s out of the money, then you may end up paying for losing your premium.

Distinguishing Between Short Call and Long Call Options

A long call option is a bullish strategy that capitalizes on the price of the assets moving upwards. On the other hand, short calls are the opposite. A short call is used to profit from the price of the security moving downwards or sideways.

Long calls grant buyers access to unlimited gains, while with short calls, the maximum gain is the call premium.

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