How to Buy Call Options for Beginners

Buying call options offers a way to participate in the potential upside of an asset without directly owning shares. This financial contract provides the buyer with the right, but not the obligation, to purchase an underlying asset at a predetermined price by a specific date. This article guides you through the process of purchasing a call option, from understanding its fundamental components to placing and managing your trade.

Understanding Call Options

A call option is a contract derived from an underlying asset, such as a stock, an exchange-traded fund (ETF), or an index. The predetermined price at which the underlying asset can be bought is known as the “strike price.”

Each call option contract also has an “expiration date,” the final date by which the right to buy the underlying asset can be exercised. The cost of purchasing a call option contract is called the “premium,” which is the maximum amount an option buyer can lose.

The relationship between the underlying asset’s current price and the option’s strike price determines if an option is “in the money,” “at the money,” or “out of the money.” A call option is “in the money” when the underlying asset’s price is higher than the strike price. If the underlying asset’s price is equal to the strike price, the option is “at the money.” Conversely, a call option is “out of the money” if the underlying asset’s price is below the strike price. One standard equity option contract typically represents 100 shares of the underlying asset.

Preparing to Trade Options

Establishing a brokerage account is the first step before engaging in options trading. Opening an account involves an online application where you provide personal, employment, and financial details.

After opening an account, you must apply for options trading approval from your brokerage. This process is required because options trading involves different risk profiles than simply buying and selling stocks. Brokerages assess your trading experience, financial situation, and investment objectives to determine your eligibility.

Brokerages categorize options trading capabilities into various “levels.” For buying call options, you typically need Level 1 or Level 2 approval. Once approved, fund your brokerage account to cover the cost of option premiums and any associated fees. Most brokerages provide tools for researching options.

Placing a Call Option Order

Once your account is established and approved, navigate your brokerage platform to access the options chain for your chosen underlying asset. The options chain displays available call and put options, organized by expiration date and strike price. Selecting a call option involves choosing a specific strike price and expiration date that align with your market outlook. For example, if you anticipate a significant price increase, you might select an out-of-the-money strike price you expect the asset to exceed.

When reviewing the options chain, you will find “bid” and “ask” prices for each contract. The bid price is the highest price a buyer will pay, while the ask price is the lowest a seller will accept. The difference is the bid-ask spread, which reflects the option’s liquidity and can impact the price at which your order is executed.

Choosing an order type is important. A “market order” buys the option immediately at the best available price. While fast, the final price might fluctuate. A “limit order” allows you to specify the maximum price you are willing to pay, providing price certainty, though your order may not fill if the market price doesn’t reach your limit. For options, limit orders are generally recommended to control your entry price.

After selecting your strike price, expiration date, and order type, specify the quantity of contracts. Review all details—underlying asset, strike price, expiration date, premium, quantity, and order type—before submitting your order for execution.

Monitoring and Managing Your Call Options

After purchasing a call option, monitor its performance through your brokerage account. The option’s value fluctuates with changes in the underlying asset’s price, time decay, and market volatility. Tracking these movements allows you to assess profitability.

Most call option buyers sell their contracts before expiration to realize profits or limit losses, rather than exercising them. Selling to close an option position involves placing a sell order for the contracts you hold, allowing you to exit the trade and convert your option into cash.

Exercising a call option means buying the underlying shares at the specified strike price. While a right, it is less common for individual investors due to the capital required. Brokerages often automatically exercise in-the-money options at expiration unless instructed otherwise.

If a call option expires “out of the money,” the option will expire worthless, and you lose the premium paid. If it expires “in the money,” it will typically be automatically exercised by your brokerage, resulting in the purchase of the underlying shares unless you sell to close the position.