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How investors use call options as leverage in a portfolio

Investing is not much different from martial arts. The winners are not determined by brute force, but by reaction time and technique.

Call options are one of the techniques that, when used correctly, can lead to good profits. BUT (and this is a big but), like any investment, if you miscalculate (which is easy to do), you will lose lot money.

This is why call options are designed for experienced investors who know how to calculate the time. financial markets better than your average newbie shopper.

What is a Call Option?

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A call option is a contract that gives you the ability, but not the obligation, to buy stocks, bonds, commodities, or other securities at a fixed price for a specified period.

Here are a few different terms you need to know when it comes to buying calls:

  • Execution price – the price of each share under the call option.
  • Prize the price of the call option contract itself.
  • Best before date – the expiration date of the call option, usually in a week, month, or three months.

Let’s say TSLA sells for $ 100. You think it will go up to $ 120, so you buy call option for strike price 100 dollars and option the prize $ 3 per share.

Remember you are not buying stocks yet, just right buy 100 shares at $ 100 apiece. So you just paid $ 3 x 100 = $ 300 for a call. option… It expires in three months, so you have time to watch the market volatility.

The TSLA will rise to $ 120 as you predicted, so you exercise your call and buy your 100 shares at $ 100. Let’s calculate how you did it.

  • Your total call premium was $ 300.
  • Your strike price for TSLA shares is $ 100 x 100 = $ 10,000.
  • In total, you paid $ 10,300.
  • Your shares are now worth $ 120 x 100 = $ 12,000.
  • So you’ve made $ 12,000 – $ 10,300 = $ 1,700.

If you put in some more serious cash and bought 10 calls for $ 100,000 plus a $ 3,000 premium, your profit would multiply 10x = $ 17,000. Maximum benefit right there

How is a call option different from a put option?

A to put option just the opposite call option… This contract that you pay small the prize in order to obtain the right, but not the obligation, sell v basic shares at a certain price point within a certain period.

What is a Covered Call?

A covered bell this is when you sell call options on the stock that you actually own. Covered calls are used to generate a small extra return on stocks in your portfolio that you think will remain stable or even fall, while others think they will rise.

In particular, covered call options are “covered” because you actually own the stock and can sell if the holder of your call chooses to exercise his or her right to buy (as opposed to the short option described below).

Suppose you own 1,000 shares of AAPL at $ 100 and sell your call options at a strike price of $ 110 and a premium of $ 3. Another buyer thinks the AAPL is about to rise, so he buys all 10 of your calls.

Remember, you haven’t sold them the shares yet, you just have the right to buy them if they decide to exercise the option. You are betting that AAPL stock will remain stable or fall and the buyer will not buy. The buyer, by contrast, is betting that your stock will rise in value enough to offset his premium and strike.

It turns out the AAPL doesn’t rise above $ 105 by the expiration date, so your buyer is allowing the options to expire. Your covered call paid off. You keep your shares and buyer’s premium of 3 x 1,000 = $ 3,000.

What is a long call?

A long call is when you buy a call because you think prices will eventually rise before it expires.

In the above example, the buyer of your call options called long. They believed that AAPL prices would rise high enough to offset both their premium and strike by the expiration date. In this case, the strike price was higher than the current market value, which meant that the call was “Without money”

If AAPL had going up to, say, $ 150 before expiration, they would exercise their call options to buy 1,000 of your shares at $ 110 = $ 110,000. With the $ 3,000 premium, they paid you $ 113,000 for 1,000 AAPL shares, which are now worth $ 150. Their total profit is $ 150,000 – $ 113,000 = $ 37,000. Their long call paid off.

What is a short call?

If a covered call is a sale of stock options that you currently own, short call sells stock options that you not currently own. This is a high-risk strategy that advanced investors and hedge funds can use to influence the market, make premiums, and drive stock prices down.

To use a realistic (albeit unfair) example, suppose the market indicates that Xeris Pharmaceuticals stock is about to skyrocket from $ 100 to $ 200 thanks to a new miracle drug. You believe the drug will be rejected by the FDA, so you are offering 100 short calls for $ 150 with a $ 5 premium and a 1-month shelf life.

You tell the market, “I promise to sell you 10,000 shares of XERS for $ 150 over the next month at a $ 50,000 upfront premium.”

The market thinks you’re nuts and buys all 100 of your calls. You immediately receive 100 x 100 x $ 5 in premiums, or $ 50,000.

In the first scenario, let’s say the drug is rejected and the XERS stock falls to $ 50. Nobody takes your calls, so keep your $ 50,000 premium.

In the second scenario, say XERS stock did will rise to $ 200 by the end of the term. All of your buyers are exercising their options, but you have no stock to sell. You now need to buy 10,000 shares at $ 200 and resell them to the call buyers at the strike price of $ 150. Your net loss (excluding commissions, etc.) is 10,000 x ($ 200 – $ 150) = $ 500,000 minus your $ 50,000 premium = $ 450,000.

This example shows why short calls are so dangerous.… The maximum upside potential for short calls is the premium alone, or, in this case, $ 50,000. But the disadvantages are endless; if XERS soared to $ 1,000 per share, you would have lost millions.

Are Call Options Safer Than Other Investments?

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Call options are often considered very risky. assets… They are inherently complex, and because they are more often traded by advanced investors and institutions relying on unlimited market data, hobbyists can quickly find themselves in the red. faces a lot possible losses

While it is good to understand the basics of call options, do not consider them until you are more experienced. investor… There are many Money on the line if you don’t know what you are doing. Better to stick with less risky assets For example, unit trust

Read more: How to Invest: Important Tips to Get You Started with Investing

When are call options useful?

Leverage in Your Portfolio: How Calls Increase Your Money - When Are Calls Good?

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There are three common reasons more experienced investors might want to use call options (Once again, I must reiterate that this is not a suitable investment for beginners.).

Income

Selling options is a quick way to make a few dollars on existing assets. As shown in the example above, you can sell a covered call for stocks in your portfolio that you think will remain stable or even lose slightly in value. There are tools like E * TRADEWith Finding Income Options which can help you identify stocks in your portfolio that are ripe for passive income.

In addition, selling calls with a strike price higher than the current market price is a low-risk profit-seeking strategy; even if your buyer’s long call pays off and they exercise their right to buy, you still earn their premiums plus the difference in buy and strike prices.

Low-risk speculation

Calls also give you the ability to “invest” in stocks without having to buy the stock in advance.

Let’s say you foresee a skyrocketing TSLA stock, but you need time to save or sell other positions in order to afford some TSLA. You can lock in a decent strike price by paying a few hundred dollars in premium today and buying time. Later if TSLA not go up like you thought, you can just let your options expire.

Tax management

Call options are also a common way customer can prevent a “taxable event” at the expense of realized profits.

Let’s say you want to squeeze income out of 100 AMZN shares. You can sell, but commissions and capital gains taxes will be charged on your newly realized profits.

Read more: Profit and loss: what will be taxed and what can I claim?

Thus, instead of selling your position, you can sell the covered option on your shares. In this case, the only cost to you is customerit’s time and legal bill to create options contract… Many option sellers (also known as online brokers) can enter options contracts for a low commission, and as soon as you customer collects them, you can reap in the prize immediately.

Summary

Call options financial contracts which you can use to squeeze a little extra income from your existing portfolio and help you invest in warehouse market without prior purchase of shares.

Make no mistake; options trade it is an advanced investment technique (maybe not a black belt, but maybe a yellow belt right in the middle). It is also worth reiterating that short calls can unlimited risk for small, immediate stature, so they are not at all suitable for beginners dealer

But if you learn it and take your time, options trading can move your portfolio up a bit.

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