Options investments are becoming popular these days for individuals looking to benefit from the derivatives form of trading. Options are derivative contracts in the financial market that gives holders a choice but not an obligation to purchase or sell an asset within a specified date at a predetermined price.
There are two types of options, namely, call and put options. Below, we review the basics of call options, including what it is, how it works, and why you should venture into call options. Plus, we will give you an overview of the difference between a call and put option so you can fully understand these financial contracts.
In This Guide
Basics of Call Options: What is it and How Does it Work?
What is a Call Option?
A call option is a derivative contract between a buyer and seller, where you agree to buy an underlying asset at a predetermined price (strike price) within a specified period. Remember, you are not obligated to make the purchase, but you must pay a premium fee to the seller to obtain the right to buy an asset. This means that the seller is obligated to deliver the asset if the buyer requests.
Note that a call option will cease to exist after the specified date for making a purchase lapse, leaving it worthless or non-existent. To invest in call options, you must create an account with a broker of your choice that meets your trading requirements. Once you have an account, it is important to engage in the process of learning to trade options. This involves acquiring knowledge and understanding of options trading strategies, market dynamics etc.
You can trade call options on various financial assets, including stocks, forex, commodities, etc.
How Does a Call Option in Stocks Work?
A stock call option works by letting an investor enter into a derivative contract that gives them the right but not the obligation to buy 100 shares of an underlying stock. An investor must pay a premium fee to a seller to gain the right to conduct the purchase.
When entering into this derivative contract, remember that an asset’s price may rise above the break-even point or fall. In call options, we expect an asset’s value to rise above the predetermined/strike price point so that you can sell the call option for profits. Some investors will opt to buy the call option at the agreed-upon strike price and sell it later at their own preferred time.
An asset’s value in the call option may also reduce below the strike price, meaning it moves in the opposite direction as anticipated. When this happens, you will not make the purchase but let the contract expire worthless. The premium you pay to the seller will be your loss.
Example:
An investor wants to put up his money in company ABC stocks, which trade at £100 per share. The company’s call option’s value is £20, and since the investor expects the value of company ABC to go up. In this case, he buys a call option on 300 shares and pays the seller a premium amount of £6,000 (£20×300 shares).
When the value of company ABC shares increases, the call option is also expected to rise even faster than the company’s share price. For instance, if the call option’s value increases from £20 to £30, the investor will sell it for a profit of £10 per share(£30-£20). This means his total profit in the call option investment will be £3,000 (£10×300 shares).
Put and Call Options Explained
As mentioned earlier, there are two types of options. Besides the call option, investors also venture into put options. The fundamental difference between a call and a put option is that a call option gives an investor the right to BUY an asset at a predetermined price within a specified date. In contrast, a put option lets you SELL an asset at a certain price within a specified date.
Simply put, a put option’s value increases as an asset’s value reduces. It acts as the opposite of call options and carries the same risks and rewards. For instance, options give you an opportunity to get exposure to the stock market at a relatively low price. Put and call options can bring about massive gains, but remember, you risk losing your premium should your trade turn out against your speculation.
Top 3 Brokers For Trading Call Options
You need the best broker to trade call options. Note that the broker should not only be safe but also offer reliable resources for market analysis and skills development.
Fortunately, we did the necessary due diligence by testing and comparing options brokers in the UK. Below are our top three that met all our set requirements. Remember, not all of them will suit your needs. Therefore, compare their features before making a choice.
1. AvaTrade
Call options trading at AvaTrade comes with competitive pricing, making us highly recommend it to low-budget traders. Besides, the broker has an intuitive design and user-friendly platform perfect for beginners. Besides desktops, traders can also use AvaTrade on Android and iOS devices. All you need is a minimum deposit of £100 to get started.
Note that AvaTrade hosts an AvaOptions trading platform that allows you to trade call and put options. On this broker, you can also trade call options with stop and limit orders, which you can easily trigger at a predetermined level. On top of that, AvaTrade offers call options trading learning resources for skills development. Feel free to test it out on its demo account before trading the live markets.
✔ Quick deposits and withdrawals
2. IG Markets
If you are an experienced trader looking for a reliable call options trading platform, IG Markets is a considerable choice. Not only can you trade options on stocks, but also forex, commodities, etc. Plus, IG Markets is one of the largest CFD brokers globally, meaning using it gives you plenty of opportunities to speculate on short-term positions.
Keep in mind that IG Markets is a secure call options broker because of its long track record and is regulated by world-renowned authorities, including the FCA. To trade call options, a minimum deposit of £300 must be made. However, you will not pay spreads on the call option’s fixed expiry date. There are also no commissions except when taking positions on shares. Like AvaTrade, IG Markets is compatible with all devices, making it easier for you to trade anywhere, anytime.
✔ Leading broker with low fees
3. Plus500
If you are always on the move and want to invest in call options, Plus500 is the best broker to go for. Most user testimonials on Google Play and the App Store claim that it executes trades seamlessly on mobile devices, whether Android or iOS. Note that you will not incur commissions when trading call options as CFDs on Plus500. However, spreads apply, but they are among the lowest in the industry. Plus500 is a CFD broker for low-budget traders. Simply sign up for an account and deposit at least £100 to get started.
Regarding security, Plus500 is regulated by world-class authorities like FCA and CySEC. Its support service operates 24/7, and using it also allows you to set price alerts, stop-loss, and trailing-stop orders to mitigate risks in call options trading. On top of that, the broker’s leverage on CFD options trading goes up to 1:5.
✔ Regulated in many countries
Note: 80% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.
Pros and Cons of Call Options
As mentioned earlier, call options give you exposure to the stock market at a low price. Below are the advantages and disadvantages of call options to help you make informed trading decisions.
- Purchasing a call option with increasing value than the strike price might bring about massive earnings.
- Call options premiums are lower than put options.
- Each share attracts a premium earning when you sell your call option above the strike price.
- A call option’s value becomes worthless if a stock price falls below the strike price.
- Failure to purchase an asset as agreed on the derivative contract results in losing your premium amount (money paid to the seller).
- You risk losing stock shares should a sold call option be executed below the spot price (current market price).
Ways to Trade Call Options
There are two ways to trade call options, namely short or long call options. So what are they, and how do they differ? See below.
Long Call Options
A long call option is the regular call option where traders enter into derivatives contracts that gives them the right to buy stocks at a predetermined price within a specified period. The best element about the long call option is that it gives you an opportunity to purchase stocks at a lower price. Additionally, profits in this options trading category are unlimited, whereas losses are capped to the premiums paid to the seller. Since you will be trading using brokers, ensure you understand the commissions or spreads applicable to ensure you trade under budget.
Short Call Options
Short call options require traders who are extremely bearish about their underlying assets. For instance, you can take a short call option when you believe that a stock’s value will keep decreasing significantly. Here, you act as the seller and expect to benefit from the buyer’s premium in case a stock’s price reduces below the strike price. Also, you get to keep the stock the buyer failed to purchase.
Learn about best options trading platforms in the UK in our other comprehensive guide.
FAQs
You should buy a call option when you are optimistic that the market will become bullish and the asset you invest in will increase in value. Note that the call option derivative contract mandates you to pay a premium fee to the seller. You could lose this amount if an asset’s price you are trading does not rise above the strike price.
Absolutely. Call options traders can lose their premium fees paid to the seller if an asset’s price reduces instead of rising as stipulated in the derivatives contract. If you trade call options as CFDs using leverage, you also stand a chance of incurring massive losses. Therefore, always ensure you are certain of the direction an asset’s price will take before investing in call options.
The value of a call option is determined by the value of an asset. For instance, when a particular stock price rises, the call option will also increase. The more a call option goes up, the higher the amount of profits you will earn.
Once you realise that the value of an asset you are trading in a call option is likely to fall, you should close your position by selling your call option. Note that when an asset’s value decreases, your call option derivative contract will expire worthless, leaving you with losses.
While options trading will give you exposure to the stock market at a low cost, trading them will depend on how well you understand an asset’s market. Therefore, whether you trade stocks or options, the bottom line is that you can be strategic and trade with the best broker.
If you do not sell your call option when an asset’s value hits below the strike price or the expiry date lapses, your contract will expire worthlessly, and you will lose all your premium fees. However, if the asset’s value keeps increasing before the expiry date, you will gain more profits.
Conclusion
Buying a call option is one of the strategies you can use to magnify your gains on an asset’s price. However, while this trading method can be risky, you get an opportunity to earn profits from the gains of an asset at a low fee.
Since there are numerous assets for call options trading, ensure you conduct thorough research to select the one with growth potential. The last thing you want is to lose your premium amount paid to the seller due to poor strategy. Also, choose a call options broker that will fully support you with adequate resources for maximum potential.
Related Articles:
