Options Trading Tutorial | Call Options Explained

In the next post of the options trading tutorial series we'll talk about call options. A call option represents the right to buy a specific number of shares of a company or other asset at a specific price on (or before - in the case of Standard -or American- options) a specific date.

Call Options Explained

A call options trading tutorial has to talk about three critical pieces of information: the strike price, the expiration, and the call premium. Each of these bits of information play a critical role in determining the ultimate return on investment for the options trader.

Call Options: Explaining the Strike Price
The strike price of a call option is the price at which the option holder (long position, or buyer of the call option) has the option to pay for a set number of shares of stock (or some other asset) on or before a certain date. If the shares of stock (IBM for example) is trading ABOVE the strike price of the option, the option is considered "in the money." A call option buyer (or LONG) would be able to execute the option contract, forcing the counterparty to deliver the specified shares at the strike price. The option holder (now a share holder, given that the shares have been delivered) would have the freedom to re-sell the shares into the market at a higher price (see put and call option trading examples) and therefore cashing in the difference between the price paid (strike) and price sold for (market) as trading profits.

Call Options: The Expiration Date Explained
The expiration date on a call option (standard or American options) refers to the date on or before which an option must be exercised otherwise it expires (or can be subject to automatic options execution - not always a good thing for the trader short of cash). A call option which expires out of the money is worthless while an in the money option pays a profit (explained above - the difference between strike price and the market price of shares less the call premium times the number of shares in the contract). On *MOST* stock options contracts, the expiration is the third Friday of the month at the close of trading in New York (4pm EST). Sometimes there are options contracts which expire at the end of a quarter. It is extremely important to know when your options contracts expire, and to have your trades settled long before then unless you intend to exercise the contracts (a rarity these days because of the huge cash commitment involved... and the fees).

Explaining the Call Premium
The call premium on a call option contract is the fee the buyer of the contract pays to the seller of the contract (through a clearing house - to be explained elsewhere later). The call premium is essentially the market price of the contract - meaning the "fair" price the market has established for the contract based on a number of factors, including the probability of in the money expiration, the risk free rate, the volatility of the market, the number of days before expiration, and the current price of the underlying stock or asset.

In this options trading tutorial on call options we explained call options premiums, expiration dates, and strike prices. Options trading is risky and can result in significant losses of capital.