5 Additional Options Advantages | Stock Investor
When you purchase a call option you get a contract that entitles you to buy the underlying commodity or financial instrument, such as a share of stock, at a guaranteed price called the strike price. You pay a fee called a premium for the call option, and you can exercise your right to buy until main advantages of the option option expires. Call options have advantages that make them powerful tools for investors.
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Increased Cost Efficiency The premium for a call option costs far less than the equivalent underlying security. The resulting leverage increases the potential return on your investment.
That is a percent profit.
Risk & Reward
Limited Risk Compared to Equities Call options have a reputation for being high-risk investments, and in some ways that is true. Suppose the price of the underlying security for a call option does not rise above the strike price before the option expires.
The option is worthless and you lose all the money you put up. However, the premium is the limit of your risk.
If the shares you bought of XYZ Corp. Collecting Premiums Through Covered Calls You can generate additional income by switching roles and selling call option contracts. When you are the seller, you are known as the option writer.
Suppose you own stock that has appreciated since you bought it.
You can write a call option with a strike price equal to the current market price and collect a premium. In options trading, this is referred to as a covered call.
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If the call option you wrote is exercised, you sell the shares you own to complete the contract. You keep the premium along with the gains you made on the stock up to the strike price.
The premium then offsets part of the loss from the fall in the stock price. Multi-Pronged Flexible Strategies Trading call options allows you to employ a variety of income-enhancing and risk-reducing strategies using combinations of options and the underlying security.
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This strategy involves two call options that are identical except for the strike price. You purchase a call option with a strike price near the market price and simultaneously write a call option at a higher strike price.
The premium you collect for the call you write offsets all or part of the premium you pay for the call option you buy. This does limit the potential profit, since if the price of the underlying security rises above the strike price of the option you wrote, any further gains on the call you bought are offset by losses on the call you wrote.
Increased Cost Efficiency
However, a bull call spread has the effect of reducing your up-front investment and hence your risk. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University.
He became a member of the Society of Professional Journalists in Read More:.