Help in buying an option. Key takeaways
Like stocks, options are financial securities. There are 2 types of options: calls and puts. Calls grant you the right but not the obligation to buy stock. If you are bullish about a stock, buying calls versus buying the stock lets you control the same amount of shares with less money.
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If the stock does rise, your help in buying an option gains may be much higher than if you simply bought and sold the stock. Of course, there are unique risks associated with trading options. Read on to see whether buying calls may be an appropriate strategy for you. The basics of call options The buyer of call options has the right, but not the obligation, to buy an underlying security at a specified strike price.
That may seem like a lot of stock market jargon, but all it means is that if you were to buy call options on XYZ stock, for example, you would have the right to buy XYZ stock at an agreed-upon price before a specific date.
The primary reason you might choose to buy a call option, as opposed to simply buying a stock, is that options enable you to control the same amount of stock with less money. The characteristics of call options Compared with buying stock, buying call options requires a little more work. Knowing how options work is crucial to understanding whether buying calls is an appropriate strategy for you. There are several decisions that must be made before buying options. These include: The security on which to buy call options.
Suppose you think XYZ Company stock is going to rise over a specific period of time.
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You might consider buying XYZ call options. The trade amount that can be supported. This is the maximum amount of money you would like to use to buy call options. The number of options contracts to buy. Each options contract controls shares of the underlying stock.
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The strike price. This is the price at which the owner of options can buy the underlying security when the option is exercised. The price to pay for the options. This is the price that it costs to buy options. The expiration month.
Options do not last indefinitely; they have an expiration date. If the stock closes below the strike price and a call option has not been exercised by the expiration date, it expires worthless and the buyer no longer has the right to buy the underlying asset and the buyer loses the premium he or she paid for the option. Most stocks have options contracts that last up to nine months.
Traditional options contracts typically expire on the third Friday of each month. The type of order. Like stocks, options prices are constantly changing. Consequently, you can choose the type of trading order with which to purchase an options contract. There are several types of orders, including market, limit, stop-loss, stop-limit, trailing-stop-loss, and trailing-stop-limit. Now, compare that with the cost of buying the stock, rather than buying the call options.
This illustrates the primary purpose of options.
They effectively allow you to control more shares at a fraction of the price. The ultimate goal is for the stock price to rise high enough so that it is in the money and it covers the cost of purchasing the options. Advantages and disadvantages In addition to being able to control the same amount of shares with less money, a benefit of buying a call option versus purchasing shares is that the maximum loss is lower.
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Plus, you know the maximum risk of the trade at the outset. If the stock decreased in value and you were not able to exercise the call options to buy the stock, you would obviously not own the shares as you wanted to.
Another disadvantage of buying options is that they lose value over time because there is an expiration date. Stocks do not have an expiration date.
Also, the owner of a help in buying an option receives dividends, whereas the owners of call options do not receive dividends. This is particularly true for options trades. The maximum potential profit for buying calls is the same profit potential as buying stock: it is theoretically unlimited. The reason is that a stock can rise indefinitely, and so, too, can the value of an option.
Conversely, the maximum potential loss is the premium paid to purchase the call options. If the underlying stock declines below the strike price at expiration, purchased call options expire worthless. If the stock does not rise above the strike price before the expiration date, your purchased options expire worthless and the trade is over.
How you make an options trade You must first qualify to trade options with your brokerage account. At Fidelity, this requires completing an options application which asks questions about your financial situation and investing experience, and reading and signing an options agreement. Assuming you have signed an options trading agreement, the process of buying options is similar to buying stock, with a few differences.
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You would begin by accessing your brokerage account and selecting a stock for which you want to trade options. Once you have selected a stock, you would go to the options chain. An options chain is where all options contracts are listed.
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Then you would make the appropriate selections type of option, order type, number of options, and expiration month to place the order. With the knowledge of how to buy options, you can consider implementing other options trading strategies. Buying call options is essential to a number of other more advanced strategies, such as spreadsstraddlesand condors. Once you master buying calls, the world of options opens up. Next steps to consider.