It has been a year since the historic GameStop event – where the stock market was shaken by a large group of internet investors. During that time, ordinary – even first-time – investors made a lot of money as they drove the share price of GameStop up. On the other hand, hedge funds shorting the stock went into the red.
While events like that rarely ever happen, it’s still worth looking into the fundamental concepts surrounding it, if only to see how they apply to other, less outrageous situations.
One of the lessons from the GameStop saga is understanding what a call option in trading is. This article will discuss that.
What are Call Options?
Call options give buyers the option, but not the requirement, to buy a stock, commodity, bond, or any underlying asset at a specified price or strike price by a specified expiration date. The buyer pays the seller for this right with a specified amount called a premium. These options cease to exist after the expiration. They end up either having some value or not.
Here are the components that make up the call option:
- Premium – The price of the option paid for by the buyer to the seller.
- Strike Price – The price the buyer can purchase underlying assets.
- Expiration – The specified time when the option expires.
The buyer of the call option can choose to sell the option any time before the expiration. Alternatively, they can also choose to put up cash to purchase the stock at the strike price. Call options are considered ‘in the money’ when the asset price surpasses the strike price by the time they expire.
On the other hand, call options are ‘out of the money’ when the asset price is below the strike price upon expiration. In this case, the seller keeps the premium and the option is worthless.
How to Make Money with Call Options
Traders typically make money with call options in one of two ways: Buying or selling them.
Buying Call Options
Buyers can make a lot of money with a call option since it can magnify the gains in an underlying asset’s price, for a relatively low upfront cost. People buying a call option usually expect the price of that asset to rise above the strike price. A buyer’s profit can be calculated using the following equations:
- Profit = payoff – premium
- Payoff = spot price – strike price
The payoff has to exceed the premium for the buyer to make money. At worst, the buyer can lose the entire premium, but nothing more.
Selling Call Options
On the other hand, a call option seller makes money when the asset price does not exceed the strike price. Sellers usually expect the asset to remain flat or decline by the expiration date. Unlike buyers, the maximum profit a seller can get is equal to the premium. It is calculated using the following equations:
- Payoff = spot price – strike price
- Profit = payoff + premium
A seller can lose much more than the premium, depending on how much the asset price surpasses the strike price. During the GameStop event, many hedge funds lost money this way.
Conclusion
Call options are another way for traders to earn money in trading. By learning about this instrument, traders can better take advantage of several markets. They can also limit their losses or maximize their profits, depending on which side of the call option they want to pursue.
For more information about call options or binary options trading, get in touch with our 24/7 live support through email (support@trustedoptions.com) or phone (+1 (888) 901-5028). Trusted Options equips our traders with all the tools and resources to make money in binary options trading.