Understand How Buying & Selling Call Options Works

The world of options trading can be confusing at first but as soon as you get a hang of the basics, you’re good. When it comes to buying or selling call options, all investors should follow specific strategies for when to sell a call option.

If you’re looking for a profit, be sure to sell a call option when the time is right — we’ll discuss when to sell a call option for the best returns.

Let’s see what we’re dealing with first and then understand the profitability of knowing when to sell options before expiration.

What Is A Call Option?

A call option is a derivative contract that gives buyers the power to buy a stock at any price. This is quite appealing as the owner can decide on a final price for the stock when the time comes. It all comes down to the buyer who can use the option when the stock price increases.

The expiration date for call options can vary, hence it’s favorable for traders.

Let’s see how you can maximize your gains when deciding to sell call options before expiration.

How Do Call Options Work?

Call options are merely financial instruments and their total value depends on any underlying asset.

Let’s check a sell call option example:

If the asset is stock, you can look at it as an example to sell the call option. Let’s say a buyer ends up buying a call option for the strike cost of $150; they can purchase up to 150 shares before the option expires.

The call options owner also has the right to sell it to any other buyer, within the set period. However, if by any means, the price of the underlying stock ends up decreasing, so will that of the call option.

Many investors prefer buying call options for the following reasons:

Speculation

Call options give the owners an option to make profits if the stock price ends up increasing, by only spending way less than the actual stock price. This can be a great long-term investment as you’ll be earning more by only putting in a fraction.

It’s all about speculating if the stock price will go in your favor.

Of course, the exact opposite may also happen, but if you’re good at spotting trends, you won’t have to worry about it.

Hedging

Many companies and investors use call options for hedging. It follows the same principle as an investment. The goal here is to minimize the risk associated with a financial asset by investing in another (hedge), related one, via a call option.

Buying A Call Option

The main reason why you should buy a call option is to get double a stock’s price.

You can just pay a meager amount and wait for the stock price to increase. If you’re wondering whether you can sell a call option before it hits the strike price, the answer is yes. The buyer has the right to exercise the call option and enjoy their gains before the expiry date.

However, if the stock price ends up dropping, the buyer will lose the amount of money they put in initially.

Selling A Call Option

The whole idea of buying a call option is to sell it for profit, whether you hand it over to another party or buy the corresponding stocks.

In either case, the goal is to maximize the profit.

Based on the call option profit formula, you should hope that the stock price stays flat. This way, the buyer will pay you a premium price without you having to face any losses.

Ideally, a call option seller should have enough of the stock and be able to afford the stock and deliver the stock if a buyer is in the picture.

The biggest advantage of selling call options is that you receive a premium payment, and you just have to wait till the expiry date. If the strike price stays flat, you make enough profit. As a call option buyer, you don’t get any of these benefits because you’re not the one investing.

If you’re selling call options for income, you have two options:

Naked Call Option

When the seller puts up the call option for sale without fully owning the assets, then it’s a naked call option. This carries a lot of risks because the seller has not technically purchased the entire stock, if the price increases, it’s a loss for the seller.

In several instances, call option sellers chose the wrong time to sell and lost a fortune.

This is an important disclaimer for the sake of transparency!

You should always check out the market’s conditions before you make any move.

Covered Call Option

This strategy means that the car option seller owns the underlying stock. The covered call option carries little to no risk because you simply purchase the stock before it reaches its strike price.

Also, if you’re wondering “can you sell a call option before it hits the strike price?” The answer is yes — options can be traded anytime.

Selling call options involves low risks and high profitability if you do it right.

Investors must keep their eyes locked on the stock price to decide the right time. Looking to generate a safe income from selling? You can opt for the covered call option as a protective measure.

If the stock market is going through a rough time, you can likely grab some profit by selling call options.

Call Option VS. Put Option

Call options and put options are two completely different assets.

The former gives you the power to buy a stock before it hits the expiry date. Whereas, put options allow you to sell the stock for any specific price before it expires. Both of these trading strategies offer the same profits and risks — it all comes down to your preference.

You’d normally buy a put option as a safeguard measure. Say you feel that the stock price for a certain company may drop, and you buy a put option for it beforehand based on its current price. Now when the price drops (before the expiration of the put option), you can sell a given number of shares at the original price.

We know that investing can be tricky, but if you know when to sell options before expiration, you can circumvent potential risks and maximize profits.

Happy trading!

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