Purchasing a call option allows you to participate in the upside of a stock. The buyer of call options has the right, but not the obligation, to buy a stock at a specified price. The call option gives you flexibility to own stock later if it appreciates, while not requiring you to invest in it during the interim if it does not. For this, you pay a premium. While there’s upside potential in purchasing a long call option, you can lose the entire amount invested in the long call option strategy.
Example: Suppose a friend of yours tells you about an up-and-coming software technology company that trades under the ticker IOIO. She says that with the recent release of their new proprietary coding software, the stock should double within the next 3 months. You understand that technology companies are risky investments but that by buying a call you could participate in the upside without having to buy the stock from the onset. IOIO currently trades at $10. The call option with a strike of $10 is trading at $2. In order to break even on your long call option strategy, the stock needs to trade up to $12. You purchase 1 call option with a strike price of $10 and expiration of 3 months at $2, paying $200 in total. For the next three months, the stock rallies all the way up to $18. Just before the option’s expiration date, you decide to exercise the right to buy the stock at $10. You pay $1,000 for the stocks (which are now worth $1,800). In total you have an unrealized gain of $600 on the stock which you were able to lock in by only paying $200 for the option. Conversely, if the stock never exceeds $10 by the expiration date, you stand to lose the initial $200 invested. If you had purchased the 100 shares at $10 at the onset for $1,000, you could stand to lose your entire investment of $1,000 if the stock price declined to zero.
Option trading entails significant risk and is not appropriate for all investors. Option investors can rapidly lose the entire value of their investment in a short period of time and incur permanent loss by expiration date. You need to complete an options trading application and get approval on eligible accounts. Please read the Characteristics and Risks of Standardized Options and Option Spread Risk Disclosure before trading options.