What are Stock Calls?
Wouldn’t it be great if you could make a bet on a stock that you thought was going to increase in price, but hedge that bet so that if you were wrong you wouldn’t lose all of your money? That, in essence, is how a stock call works. It is more sophisticated than simply buying or selling a stock. By understanding how a stock call works, you can add a valuable and flexible investment option to your toolbelt.
No obligation involved. The key difference between the purchase of a stock and the purchase of a call option on a stock is that the owner has choices. There is a contract that sets out a stock price and a time frame within which to make a purchase. You pay money for that contract, but you don’t have to buy the stock. A stock call gives you the right to make the purchase but you are not obligated to do so. Since the cost of a call option on a stock is much lower than the stock itself, that option is extremely valuable.
Stock call lingo. If you are going to consider using stock calls, it’s important to understand the investment terms associated with this investment option. If the call option is short-term, you will see an expiration month, such as June, for example. Stock options expire on the third Friday of the month. The strike price is the amount that you can sell the stock for. The premium is what you pay for the stock call. All contracts are for at least 100 shares of the stock.
Stock call example. Let’s say XYZ stock is currently selling for $25, but you believe the stock is going to appreciate in value. The stock call you are offered has a strike price of $30 and expires in three weeks. The premium for the call is $1 per share of XYZ stock, or $100 for the minimum 100 shares. If the stock reaches $38 before the expiration date, for example, you can choose to buy the call option on the XYZ stock for the $30 strike price and then resell it on the market for $38 per share. You would earn $800, minus the $100 premium, as well as any broker’s fees. If the stock had decreased in value instead, and was at $20 per share on the expiration date, you could have chosen to do nothing. You would have only lost the cost of the stock call option, or $100.