How to Buy a Call Option: A Step-by-Step Procedure

Call options are financial contracts that grant the holder the right, but not the obligation, to purchase an underlying asset at a specified price within a defined timeframe. This financial instrument allows investors to potentially benefit from an asset’s price appreciation without directly owning the asset. Buying a call option involves several steps, from understanding fundamental concepts to executing and managing the trade.

Foundational Concepts for Call Options

A call option functions as a contract, providing the buyer the privilege to acquire an underlying security. This underlying asset can be a stock, an exchange-traded fund (ETF), or a commodity. The contract specifies a predetermined price, known as the strike price, at which the underlying asset can be bought.

Each call option contract includes an expiration date, the final day the option holder can exercise their right to buy the underlying asset. Beyond this date, the contract becomes void. The cost paid by the buyer for this right is called the premium, representing the maximum potential loss for the option buyer. Typically, one options contract represents 100 shares of the underlying asset.

Call options are categorized based on the relationship between the underlying asset’s current market price and the option’s strike price. An option is “in-the-money” (ITM) if the underlying asset’s price is higher than the call option’s strike price, meaning it possesses intrinsic value. Conversely, a call option is “out-of-the-money” (OTM) if the underlying asset’s price is below the strike price, indicating no intrinsic value. When the underlying asset’s price is exactly equal to the strike price, the option is “at-the-money.”

Preparing to Trade Call Options

Before trading call options, establishing a brokerage account is a necessary first step. Many online brokerage firms offer various account types, including those suitable for options trading. The account opening process typically involves providing personal information such as name, address, Social Security number, employment status, and financial details like income and net worth.

After opening an account, investors must obtain specific options trading approval from their chosen broker. Brokers categorize options trading authorization into different levels, which dictate the complexity and risk of strategies an investor can employ. For instance, buying long calls typically falls under a different approval level than selling uncovered calls. Brokers assess an applicant’s trading experience, financial preparedness, and investment objectives to determine the appropriate approval level.

Once approved, selecting the specific call option contract to purchase involves navigating the brokerage platform’s options chain. An options chain is a tabular display showing all available option contracts for a particular underlying asset, organized by expiration date and strike price. To find a desired contract, an investor will first select the underlying asset. Then, they choose an expiration date from the available list, typically sorted with shorter expiries at the top.

Following the selection of an expiration date, the investor can review various strike prices associated with that expiry. The options chain will display quoted bid and ask prices for each option’s premium. The bid price is the highest price a buyer is willing to pay, while the ask price is the lowest price a seller is willing to accept. The difference between these prices is the bid-ask spread. Each specific option contract has a unique ticker symbol, which typically combines the underlying stock’s symbol, expiration date, an indicator for call (C) or put (P), and the strike price.

Executing a Call Option Trade

With the desired call option contract identified, the next step involves placing the trade through the brokerage platform. This process begins by logging into the brokerage account and navigating to the options trading or order entry screen. The investor then accurately inputs the specific details of the chosen call option, which include the underlying asset’s symbol, the precise expiration date, and the selected strike price.

Following the contract selection, the investor specifies the number of contracts they wish to purchase. The platform will then prompt for an order type. The two most common order types for buying options are a market order and a limit order.

A market order instructs the broker to execute the trade immediately at the best available price, guaranteeing execution but not a specific price. Conversely, a limit order allows the investor to specify a maximum price they are willing to pay per contract, ensuring the trade executes only at that price or better, though execution is not guaranteed.

After selecting the order type and quantity, the platform typically provides a review screen. This screen displays the total estimated cost of the trade, including the premium for all contracts and any associated commissions or fees charged by the broker. Finally, the order is submitted. Upon successful submission, the investor will usually receive an order confirmation, and the trade will be executed based on the chosen order type and prevailing market conditions.

Managing and Closing Call Option Positions

After purchasing a call option, ongoing monitoring of the position becomes important. The value of a call option is influenced by several factors beyond just the underlying asset’s price movement, including the time remaining until expiration (time decay) and changes in implied volatility. Implied volatility reflects the market’s expectation of future price swings in the underlying asset, influencing the option’s premium. Regularly checking the underlying asset’s price, the option’s premium, and relevant market news is part of effective management.

There are primary methods for closing an open call option position. The most common approach for realizing a profit or limiting a loss is to “sell to close” the contract before its expiration. This involves placing a sell order for the same call option contracts that were initially purchased, effectively liquidating the position. Selling to close allows the investor to capture any gains if the option’s value has increased or to cut losses if it has decreased, without needing to take ownership of the underlying shares.

Another method is exercising the option. Exercising a call option means the holder chooses to buy the underlying shares at the specified strike price. This action typically requires a significant amount of capital to purchase the shares, as each contract represents 100 shares. Investors generally exercise call options only if the option is in-the-money and they intend to own the underlying shares, or if there’s a strategic advantage to doing so, such as capturing a dividend. However, exercising is often less financially advantageous than selling to close, as selling allows the investor to capture any remaining time value in the option’s premium.

A final scenario is letting the option expire worthless. If a call option is out-of-the-money at expiration, meaning the underlying asset’s price is below the strike price, the option will expire unexercised and become worthless. In this case, the investor loses the entire premium paid for the option.