Options – Calls from a Buyer’s Perspective

August 1, 2007 | Posted by Jorge

The two basic options are calls and puts. Let’s start with the buyer’s perspective on call options. We’ll come back to the put options and the seller’s perspective on options in the near future.

Buyer – Calls

Let’s start with a formal definition from Investopedia:

1. The period of time between the opening and closing of some future markets wherein the prices are established through an auction process.

2. An option contract giving the owner the right (but not the obligation) to buy a specified amount of an underlying security at a specified price within a specified time.

A buyer may choose to purchase the simplest of options, a call or a put. A call gives the buyer the right but not the obligation to purchase set item at agreed upon price by the expiration date. Using the LVLT example from the Options – What are they? post, a buyer purchasing that call has the right to purchase 100 shares of LVLT at $5.00 per share until the expiration date in December. As you recall, expiration is defined as the third Saturday of the expiration month. Now, the basic motto of investing is buy low and sell high. Imagine purchasing a call option for $100 at a strike price of $5.00 per contract. Fast forward a month later. The stock’s market price has risen to $6.00. Is it worth exercising that option? Not really. You can buy your LVLT stock at $5 in accordance with the option and sell it immediately at $6. This leaves you with what’s known as breakeven. You didn’t lose any money but you didn’t make any either. Imagine the stock rises to $6.50 the month of expiration. $6.50 – $5.00 strike price leaves you with a spread of $1.50. Exercising your option netted you $150 – $100 premium, for a profit of $50. You turned $100 into $150, or a 50% gain. Not too shabby. Of course if the stock price goes below your strike price of $5, your option becomes worthless. But in the end, all you lost was $100 instead of the corresponding loss of owning the stock.

That’s the basic call option from a buyer’s perspective. Remember that there are many strategies on when to purchase and exercise your bought call options. But hopefully now you have the basic knowledge of what they are. Good luck!

Disclaimer: I’m not a broker or a financial advisor. These are stocks I own or plan to own in the near future. Extensive research has been made on these stocks beforehand. You understand that the no content published on InvestingAdventures.com constitutes a recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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