There’s an investment out there for everybody, even if it’s just stuffing cash into a mattress (note to self: bad idea). Even if you don’t have enough money to buy the stocks you’d like to buy.
There’s even a way to participate in the upward momentum of those stocks you don’t have enough money to buy, and without borrowing the money.
Instead of buying the stock itself, you can buy an option contract instead. Specifically, a call option which allows you to profit if the stock goes up, and limits your downside risk if it doesn’t.
Sound too good to be true? That depends on your tolerance for risk. Because there’s nothing that leverages your money quite like a well-chosen call option contract, and there’s nothing that will drain it quicker if you don’t.
Defining The Call Option Contract
A call option contract, commonly referred to as calls or call options, are contracts that give you the right to purchase 100 shares of an underlying stock at a given price, within a given timeframe.
Let’s say you have your eye on XYZ company at $18 a share. You think it may go to the moon, but you can’t risk $1800 to buy 100 shares. What you can do, though, is buy a call option contract instead, giving you the right to buy those 100 shares at a given price. In this case, you’d probably be looking at a strike price (the price at which the shares, when the option is exercised, or called, would be sold to you) of either $15 or $20.
Options always have multiple strike (call) prices, each with different market values based on how they relate to the current market price of the stock.
Who Buys, Who Sells
Few investors who buy call options hold these contracts for the full term, meaning that the actual call itself – the purchase of the 100 underlying shares – doesn’t happen. Only the investor holding the option contract at the moment it expires (which is at the very end of the contract term) is stuck with actually buying the stock at the strike price, like it or not.
And if the option is in the money – the market price is above the strike price – then they’ll very much like it, indeed. Because they are buying those 100 shares below the current market price.
Options Exchanges
Options traders buy and sell the contracts on regulated option markets (like the CBOE: the Chicago Board Options Exchange), at prices that are driven by two things: the price movement of the underlying stock (and therefore, all of the news and performance that drives the stock), and the amount of time left on the term of the option contract, which can be up to a year.
The more time left on the contract, the greater the premium within the price. A premium is the amount by which the price of the option exceeds its intrinsic value (which is the amount the stock price exceeds the strike price – for example, a stock selling for $18 with an option at a strike price of $15 results in an option contract with a $3 intrinsic value; anything over that amount is the premium).
The quoted price for options are always on a per-share basis, but the contract itself covers 100 shares. So a call option quoted at $2 will cost you $200.
Complicated stuff, but worth looking into if leverage action is your preference, and within your tolerance level.
