Stock Option Investment

Stock Option Investment. What you must know to succeed with stock option investing and online stock option trading.

Stock Option Investing: Long Call Options

With the long call strategy, you purchase the right but not the obligation to buy the underlying shares at a specific price until the option expires.

This strategy offers unlimited profit potential, while generating limited downside risk. A long call is an excellent way to get high leverage on an underlying security.

When should you use this strategy? When you believe that the underlying security will increase in price. However, you need to buy them with a substantial amount of time before the option expires, typically at least 90 days to allow time for the option to move into the profit zone.

Breakeven point

For a long call, the breakeven point would be the call strike price added to the call option premium.

How do you exit from the long call position?

If the option price rises above your breakeven point: To exit from the long call position, there are two main possibilities. First, offset the position by selling a call option with the same strike price and expiration at an acceptable profit. Otherwise, exercise the option to purchase shares at the lower strike price. With these shares, you can either sell them at the current price for profit, or hold in expectation of a further rise in stock price.

Conversely, if the option price falls below your breakeven point: offset the long call by selling an identical call to lower your losses.

Also beware of time decay in online stock option trading: option prices fall dramatically during the last 30 days of an option’s life.

Stock Option Trading Strategy: Short Call Options

With the short call strategy, you sell call options on the underlying security. Use this strategy when you expect the price of the underlying asset to fall. This strategy offers limited profit potential with unlimited risk, as the price of the underlying asset can fall to zero. What this effectively means is that the trader’s maximum reward is the amount received at the beginning of the trade. In contrast, the risk on the trade is unlimited should the price of the underlying asset rise. Thus, this is a very risky strategy if you do not cover your position.

How to exit the position

The best way to exit a short call position is to hold until expiration. When the market moves in your desired position, below the call strike price, you get to keep the premium as the call expires worthless at expiration.

In contrast, if the underlying asset rises above the strike price, your loss would be the difference between the current market price and the strike price. One way to offset your position would be to purchase a call option with the same strike price and expiration to exit the trade.