Call options and put options are the two primary type of option strategies. Below is a brief overview of how to provide from using call options in your portfolio.

The Basic Call Option

A call option provides an investor with the right, but not the obligation to purchase a stock at a specific price. This price is known as the strike, or exercise price. Other important contract terms include the contract size, which for stocks is usually in denominations of 100 shares per contract. The expiration date specifies when the option expires, or matures. The contract style is also important and can be in two forms. American options let an investor exercise an option any time before the maturity date. European options can only be exercised on the expiration date. The settlement process must also be known, such as delivering the shares in the case of exercise within a certain amount of time. (Read Investopedia's helpful clarification, "American vs. European Options.")

Writing Call Options for Income

Buying a call option is the same as going long, or profiting from a rise in the stock price. As with stocks, an investor can also short, or write a call option. This lets him or her receive income in the form of receiving the option price, or the opposite of the long position. This means the call writer has the obligation to sell the stock to the call option holder if the stock price rises above the exercise price.

In writing call options, the investor who is short is betting that the stock price will remain below the exercise price during the term of the option. When this happens, the investor is able to keep the premium and earn income from the strategy.

Combining One Call with Another Option

To create a more advanced strategy and demonstrate the use of call options in practice, consider combining a call option with writing an option for income. This strategy is known as a bull call spread and consists of buying, or going long a call option and combining it with a short strategy of writing the same number of calls with a higher strike price. In this case, the goal is for a narrow trading range.

For example, assume a stock trades at $10, a call is purchased at a strike price of $15 and a call is written at $20 for a premium of $0.04 per contract. Assume a single contract for premium income of $4, or $0.04 x 100 shares. The investor will keep the premium income regardless of the situation. If the stock remains between $15 and $20, the investor retains the premium income and also profits from the long call position. Below $15, the long call option is worthless. Above $20, the investor keeps the premium income of $4 as well as a $5 profit from the long call option, but loses out on any upside above $20 as the short position means the stock will be called away from him or her.

Bottom Line

The above call option strategies can be combined with a vast array of more exotic positions, but should provide a good introduction to the basics.

At the time of writing Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Options & Futures

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  2. Options & Futures

    A Guide To Trading Binary Options In The U.S.

    What binary options are, how they work and where you can legally trade them in the U.S.?
  3. Options & Futures

    Binary Options Tutorial

    A binary option is a straightforward yes/no trade. At expiration the option will be worth 100 or zero. No other settlement price is possible. That’s why it’s called a binary option.
  4. Options & Futures

    Binary Options FAQs - Sponsored by Nadex

    Many investors may not be familiar with binary options, but they’re actually quite easy to use. And they can play an important role in your investing strategy. Here are some of the more common ...
  5. Options & Futures

    How to Trade Volatility Using Binary Options - Sponsored by Nadex

    Binary options are similar to classic options with some slight nuances but the components used for the option’s pricing are the same; underlying market, strike (K), volatility and time.
  6. Options & Futures

    Using Binary Options to Trade Direction - Sponsored by Nadex

    Binary options are an outstanding method of trading market direction, whether it’s going up or down.
  7. Options & Futures

    Common Misconceptions About Binary Options - Sponsored by Nadex

    There are many misconceptions about binary options, so it is really important that traders understand exactly what they are--and what they are not--in order to use them effectively.
  8. Options & Futures

    Binary Options Strategies - Sponsored by Nadex

    Because of their all-or-nothing character, binary options offer traders a great way to trade on the direction of an asset or the overall market. And what makes binary options intriguing, besides ...
  9. Options & Futures

    The Benefits Of Exchange Traded Binary Options - Sponsored by Nadex

    Binary options can be a fantastic trading instrument, as long as they are structured correctly and traded on a regulated exchange.
  10. Options & Futures

    What You Need To Know About Binary Options Outside The U.S.

    Binary or digital options are a simple way to trade price fluctuations in multiple global markets.
  1. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  4. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  5. How do I determine the breakeven point for a short put?

    The breakeven point for a short put is the strike price of the option minus the premium. Selling puts is a way for traders ... Read Full Answer >>
  6. What options strategies are best suited for investing in the retail sector?

    Retail is a broad sector whose seven discrete segments all exhibit greater volatility than the broader market. The sector ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center