A call is a type of options contract that gives the owner the right to buy a stock at a certain fixed price within a specified timeframe.
Why It's Important
As I discussed in last week's word, Options, they are a good way to hedge against a downturn in the market if used correctly. Let's take an example:
Let's say a stock trades at $100 per share, and I think it's going to go up pretty soon. I could potentially buy 100 shares of stock, paying $10,000 OR I could buy a call option that would give you the right to pay $110 per share for stock any time in the next two months. My buy-in for the option is typically $1-$2 per share. So, I would pay $200 for that right at the high end. This is a sunk cost (I'm not getting it back regardless of what happens).
If I'm right and the stock goes up to $130 per share by the time the option expires, then I can exercise my option and purchase the stock at $110, therefore, making a profit of $20 per share even if I sold them right after purchase.
The weakness of the call option is that if the stock only goes up a little, the option's value can go down. For instance, if the stock goes up to $105 per share, I wouldn't exercise my option and take the loss of my $175 buy-in (sunk cost, remember).
On the flip side, this could work out great if I am completely wrong! Let's say the same stock now trades at $90 per share. Instead of taking a loss of $2,000 (110 - 90 x 100), I can just take my $175 loss and be on my way.
There are pros and cons to trading options. As always, do your research!
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