Beginners Guide to Call Buying Options
Do you want to invest in the stock market but are concerned about the capital risk? Stop worrying. We have another solution for you, that is buying a call option. It will allow you to invest in stock while only spending a modest amount of money.
To learn about them in detail, check this article.
What Are the Call Options?
A call option is a trading strategy that gives you the right to acquire a stock at a certain price and time (before the expiration date). However, you are not bound to exercise your options here.
But when you opt for exercising your call buying option, the amount you need to pay here is known as premium. The prime difference between regular stock investments and call options is that the latter has an expiry while the former doesn't.
Components of Buying a Call Option
- Strike price
It refers to the price at which you can invest in the underlying stocks.
Premium refers to the option's price, either for the seller or the buyer.
It is the period in which your option will either expire or be settled.
How Does the Call Options Work?
Buying a call option is profitable only if the pre-decided sum is less than the underlying asset's current market price on the day you exercise your options.
Here's an illustration to help you understand.
Assume you part in call option trading for XYZ for a month at ₹2500, for a price of ₹45. Here, you have the option to buy XYZ shares at the price of ₹2500 on the date the call option is executed. But, if on the settlement day, the XYZ stock price is ₹2300, executing your option will result in a loss. So, in this case, it is preferable to buy the stock on the open market.
What are Stock and Index Call Options?
Stock options refer to calls on individual stocks. For example, you can exercise your buying options on HDFC, Tata Steel, Reliance, TCS, etc. On the other hand, index call options are used to invest in a certain index. The profit and loss of such options are determined by index value movements.
Benefits of Buying a Call Option
- Call options are cost-effective. It's because you don't need high capital for investing in stocks as options are available by paying a small premium.
- Call options are not as volatile as other investment alternatives. Therefore, you can considerably reduce your investment’s risk if you manage it effectively. Moreover, even if you fail to exercise your option before expiry, you only lose the premium price.
- You can also generate additional income in the form of premiums through covered calls.
Things to Consider Before You Choose to Buy a Call Option Strategy
- Understand volatility
Volatility is an important aspect in determining the option's value. When the market is extremely volatile, price swings in either direction are very likely. If the market moves in your favour, you make a decent profit. Whereas if it is against you, losses are on the cards.
Also Read: Volatity Index & Its Impact on Equity Market
- Decode the time value behaviour
The premium price consists of time value and intrinsic value. For example, assume the call option strike price for the XYZ Ltd. stock is ₹1450. Then, the spot and premium prices are ₹1460 and ₹56, respectively. Here, the intrinsic value is ₹10( ₹1460 - ₹1450), and the balance of ₹46 is the time value.
Knowing the premium component is vital because time value reduces over time. And on the date of expiry becomes nil. So it helps you understand the real worth of your investment.
- Plan your strategy
Never rely on a single trade strategy if you want to mitigate the risk of investment. For example, if you expect the market to be volatile, choose a combination of Strangle and Straddle options. On the other hand, selling the strangle and straddle is recommended if you anticipate the market to be range-bound.
Other strategies that you may follow are covered calls and butterfly trading options.
- Hedge your risks
Call options provide you with flexibility that you can use to mitigate your risk. For example, assume you have specific stocks in your portfolio. But given the current market conditions and some major events, you are concerned that prices would decrease sharply for a short time. Here, you can consider purchasing a put option to mitigate the risk.
- Strike price selection
Many investors place trade into extremely low-cost options. It's because they have high anticipation of making profits as prices rise. Hence, they favour deep out-of-the-money strikes. Unfortunately, if you are doing the same thing, your chances of getting price levels over the strike price are minimal until the market takes a major swing. Therefore, it is recommended to go for a slightly out-of-the-money or at-the-money strike price.
Buying a call is an effective way to increase your portfolio's exposure to different assets. Moreover, you don't have to place a large amount of capital to trade in this investment strategy.
Share Market Knowledge Centre
- Demat account
- Share market
- Trading account
- Online share trading
- Intraday trading
- Futures trading
- Commodities trading
- Currency trading
All You Need to Know About Index Futures
Index futures are a combination of two things. Before you understand what are index futures, it is essential to understand an index and a futures contract. The former refers to a benchmark that is used to measure the performance of a particular stock against the index....Read More
5 Important Tips for Trading in Futures
The futures markets, with all of the numerous schemes and trading tactics, is both bewildering and intimidating for many investors. As a result, numerous future traders begin trading, earn good money and then experience significant losses because of a lack of understanding....Read More
What is Put Option Selling?
There are two ways to trade in the stock markets – cash trading and derivatives trading. Investors who have just entered the market usually look to indulge in cash trading only through equity shares and mutual funds. However, investors who have been there for a long time can indulge in complex yet profitable derivatives trading....Read More
Frequently Asked Questions
As a call buyer, you could lose up to the amount of the call premium you paid. In basic terms, your total loss is equal to the seller's total profit.
Investing in highly volatile stock can be a risky affair. Assume the stock you have bought never trades above the strike price. In this instance, your call option may expire without being exercised. If you believe in the stock's fundamentals of a firm and are optimistic about it, you should buy stock rather than a call option.
The first disadvantage, or rather, problem, is finding the perfect strike price and expiry time. You don't want to end up in a situation where your underlying stock never trades above the strike price before the contract expires. Another drawback is time decay. Since call options have an expiration date, their value decreases over time.