Types of Call Options

Types of Call Options

A call option is a contract that gives an investor the right, but not obligation, to buy a certain amount of shares of a security or commodity at a specified price at a later time. Unlike put options, call options are banking on the price of a security or commodity to go up, thereby making a profit on the shares by being able to buy them later at a lower price. 

There are two types of call options as described below.

How do call option work?

How a call option works. Call options are “in the money” when the stock price is above the strike price at expiration. The call owner can exercise the option, putting up cash to buy the stock at the strike price. Or the owner can simply sell the option at its fair market value to another buyer before it expires.

• Long call option: A long call option is, simply, your standard call option in which the buyer has the right, but not the obligation, to buy a stock at a strike price in the future. The advantage of a long call is that it allows you to plan ahead to purchase a stock at a cheaper price. For extample, you might purchase a long call option in anticipation of a newsworthy event, say a company's earnings call. While the profits on a long call option may be unlimited, the losses are limited to premiums. Thus, even if the company does not report a positive earnings beat (or one that does not meet market expectations) and the price of its shares decline, the maximum losses that the buyer of a call option will bear are limited to the premiums paid for the option.One of the more traditional strategies, a long call essentially is a simple call option that is betting that the underlying security is going to go up in value before the expiration date of the contract. As one of the most basic options trading strategies, a long call is a bullish strategy. 

  Essentially, a long call option strategy should be used when you are bullish on a stock and think the price of the shares will go up before the contract expires. For example, if you bought a long call option on a stock that is trading at $49 per share at a $50 strike price, you are betting that the price of the stock will go up above $50 (maybe to trade at around $53 per share). In this particular example, the long call you are buying is "out of the money" because the strike price is higher than the current market price of the stock - but, because it is "out of the money," it will be cheaper. This is a good strategy if you are very bullish on a stock and think it will increase significantly in a set period of time.

• Short call option: As its name indicates, a short call option is the opposite of a long call option. In a short call option, the seller promises to sell their shares at a fixed strike price in the future. Short call options are mainly used for covered call by the option seller, or call options in which the seller already owns the underlying stock for their options. The call helps contain the losses that they might suffer if the trade does not go their way. For example, their losses would multiply if the call were uncovered (i.e., they did not own the underlying stock for their option) and the stock appreciated significantly in price.A short call (also called a "naked call") is generally a good strategy for investors are either netural a bearish on a stock. However, it is often considered a more risky strategy for individual stocks, but can be less risky if performed on other securities like ETFs, commodities or indexes. 

  For a short call, you will sell a call option at an "out of the money" strike price (in other words, above the current market value of the stock or underlying security). For example, if a stock is trading at $45 per share, you would ideally sell a call option at $48 per share. However, because you are selling a call option, you are obligated to sell the shares at the low call price and buy back the shares at the market price (unlike when you just buy a call option, which reserves the right to not buy the stock).