Buying and selling call options are fundamental strategies in options trading, allowing traders to speculate on the future price movement of an underlying asset.
Buyers of call options aim to profit from potential price increases. In contrast, call options sellers bet that the underlying asset’s price will not rise above a certain amount and earn an upfront premium for writing the contract.
Understanding these strategies is crucial for effectively navigating the complexities of the options market. Here’s what you need to know to buy and sell call options.
Call options explained
A call option is an option contract that gives the buyer the right, but not the obligation, to purchase a specific quantity of the underlying asset at a predetermined price before the option expires. This predetermined price is known as the strike price. The buyer, also known as the holder, pays the seller a premium for this right to buy the asset. (1) Should the option not work in the buyer’s favor, they only stand to lose the premium paid — nothing more.
The call option seller, or writer, pockets the premium immediately. This premium is their fee for writing the contract. If the call option expires worthless and the buyer doesn’t exercise the option, the seller gets the premium’s full value.
However, suppose the asset’s price rises above the strike price, and the buyer exercises the call to buy the asset at the specified strike price. In that case, the seller must deliver the asset at the strike price, even if the current market price is higher.(2) If the seller owns the underlying asset, they sell the specified quantity to fulfill their obligation to the buyer. If they don’t already own the asset, they must buy it at the current, higher market price and then sell it to the buyer. The seller’s loss is the difference between the asset’s market price and the option contract’s strike price minus the premium received.
In a nutshell, call options involve two individuals essentially betting against each other that the price of an asset will rise or fall, and the primary risk lies with the seller.(2)
“The key to trading options safely is to be long — that is to buy options — rather than selling options,” explains Robert R. Johnson, PhD, certified financial analyst (CFA), chartered alternative investment analyst (CAIA) and chief executive officer (CEO) at Economic Index Associates. “When an investor buys an option, the most they can lose is what they paid for the option. When someone sells an option, they have a virtually unlimited liability if the price of the asset moves against them.”
How call options work
A standard equity option contract typically represents 100 shares of the underlying stock. So, if you buy a single equity call option contract, you can buy 100 company shares at the strike price specified in the contract if you exercise the option.
Options prices quoted on exchanges are the premium you pay per share for the option.(3) For example, you may see an options contract listed for $2, meaning the option’s total cost is $200 (100 shares x $2 = $200). That $200 is the premium you pay to the option seller and the total amount you stand to lose if the option expires worthless.
Call option buyer
You might buy a call option primarily if you believe the underlying asset’s price will rise on or before the expiration date. (4)
If the share price rises above the strike price before or by the expiration date, you can exercise the option to buy the asset at the lower strike price. A call option is said to be in the money if the asset’s price is higher than the strike price before the expiration date. If the option is in the money, you can exercise the call, sell the asset at the higher price and make a profit.
Conversely, the call is out of the money if the asset’s price is below the strike price at expiration. In this case, you might let the option expire worthless because you probably don’t want to pay more for the asset than its current value. An option that expires worthless would benefit the options seller because they don’t need to sell the asset. However, as the call option buyer, your loss is limited to the premium paid for the option. At the money means the share price is equal to the strike price.(5)
Alternatively, you can sell the option itself before expiration. You might do this if the option’s value has increased due to a rise in the underlying asset’s price, profiting from the difference between the option’s market price and the premium paid initially.
Call option buyer example: You’re the buyer
You buy one call option for 100 shares of XYZ Corp at $2 per share with a $50 strike price for a total premium cost of $200. Before the expiration date, the shares are trading at $55, so you exercise the call and buy the shares at $50 apiece for a total of $5,000.
Then, you sell the shares at the current market price of $55 and make $5,500 from the sale ($55 share price x 100 shares = $5,500). You profit $500 from the transaction ($5,500 from the sale – $5,000 you paid for the shares = $500). However, you must also account for the $200 premium you paid, which brings your total net profit to $300 ($500 – $200 premium paid = $300 net profit).
Now, imagine the shares are trading at $50 or below before the expiration date. In that case, you’d likely opt not to exercise the call and instead let the option expire worthless because there’s no financial advantage. Exercising the option neither gains nor loses you money on the transaction itself. In this case, you’d be out the $200 premium.
Investors can still profit from a call option without exercising the call. Many investors will sell their option contract before the expiration date once the share price has exceeded the strike price and collect their profits that way.(4)
Call option seller
You might sell a call option if you believe the underlying asset’s price will remain stable or not increase above the strike price. (5)
As the seller, you receive a premium upfront, which is yours to keep regardless of whether the option is exercised. If the underlying asset’s price remains below the strike price by expiration, the option expires worthless. You then have no obligation to sell the underlying asset at the higher price and get the premium’s full value.
However, as the call option seller, you could face significant losses. If the underlying asset’s price rises above the strike price and the buyer exercises the option, you must deliver the asset at the lower strike price.
Call option seller example: You’re the seller
Say an individual buys a call option for XYZ Corp with a $50 strike price that expires one month from now. The buyer pays a $2 per share premium totaling $200 ($2 per share x 100 shares per contract), which you, the option seller, receive upfront.
Now, let’s assume the stock price rises above the $50 strike price and reaches $60 at expiration. The call option holder exercises the right to buy the stock at the $50 strike price.
As the option writer, you must sell 100 shares of stock XYZ at $50 each, totaling $5,000. If you don’t already own the shares, known as a naked call, you must purchase them at the current market price to deliver them to the buyer. At $60 per share, this would cost $6,000. The net loss from the transaction would be $1,000 ($6,000 cost to buy the shares – $5,000 sale at the strike price = $1,000). After you adjust for the premium received, your net loss is $800 ($1,000 – $200 premium received = $800 net loss).
And because there’s no cap on how high the underlying asset’s price can rise, your potential loss is theoretically unlimited if you sell a naked call option. You can significantly reduce your risk as a seller if you own the underlying asset, known as a covered call.
Covered call options vs. naked call options
Option sellers who own the underlying asset and sell call options against it are using a strategy known as a covered call option. (6) When the seller doesn’t own the option’s underlying asset, it’s a naked call option. (7)
Here’s a breakdown of how each strategy works:
Covered call option
Position. You own the underlying asset.
Strategy. You sell call options on the same asset.
Risk. The risk is considered lower because you already own the underlying asset, which “covers” the obligation created by selling the call option.
Profit potential. Profit potential is limited because if the stock price rises above the strike price, you may have to sell the stock at that price, potentially missing out on further gains.
Naked call option
Position. You don’t own the underlying asset.
Strategy. You sell call options without owning the underlying asset.
Risk. This strategy carries significantly higher risk because you don’t own the underlying asset to cover the potential obligation if the call option is exercised. If the asset’s price rises sharply, you may be forced to buy the asset at a much higher price to fulfill the obligation.
Profit potential. Unlimited risk potential because there’s no cap on how high the stock price may rise, leading to potentially unlimited losses.
Advantages and disadvantages of call options
It’s important to understand the potential risks and rewards of buying or selling call options before using this type of investment strategy.
Advantages
Leverage. A buyer can gain exposure to an underlying asset for a relatively small upfront cost, or a seller can earn additional income from a stock they already own.
Limited risk for call option buyers. The loss for option buyers is capped at the premium paid for the contract.
Potential for significant profits. No matter how high the share prices rise, an options buyer only has to pay the strike price, which could be way below market value.
Additional income. Option sellers who employ a covered call strategy can make money from premiums while holding the underlying asset. Plus, they may realize additional gains if the share price rises but stays below the strike price.
Disadvantages
Potential for premium loss. If the share price doesn’t exceed the strike price, option buyers will choose not to exercise the call and, therefore, lose their entire premium paid.
Limited income for call option writers. Call seller gains are limited to the premiums paid by option buyers.
Potential for huge losses. Call sellers may have to sell off some of their own stock at less than market value. Or, if the call seller doesn’t own the underlying asset, they’ll have to buy it at market value and resell at a loss.
Time decay. Call options tend to lose extrinsic value as they move closer to the expiration date, meaning short-term options are riskier. For buyers, time decay is a risk because it gradually reduces the value of their options. If the underlying asset’s price doesn’t move significantly in the buyer’s favor within a specific time, the option’s value will diminish as expiration nears, potentially leading to a loss.
Call vs. put options explained
Put options are basically the opposite of call options. Specifically, a call option gives you the right, but not the obligation, to purchase an underlying asset at a set price before the option’s expiration date. By contrast, a put option gives you the right, but not the obligation, to sell the underlying asset at the strike price before the option expires. (8)
You might buy a call option if you expect the share price of the underlying asset to rise, whereas you might purchase a put option if you expect the price to fall. (9)
Why use a call option?
If you’re feeling optimistic about an asset gaining in value, this might be a good time to buy a call option. If you’re right, there is the potential to earn significant gains. But if you’re wrong, you’ll only lose the premium you paid.
On the other hand, if you strongly believe an asset’s price will remain relatively stable or at least not rise above the strike price, selling a call option can provide additional income through the premiums received from buyers.
If you expect the underlying asset to decline in value, buying a put option can be an effective way to profit from this movement.
Bottom line
Buying and selling call options are fundamental strategies in options trading, letting traders speculate on the future price movement of an underlying asset. They give the buyer the right to purchase an asset at a set price before expiration, while call option sellers receive a premium for writing the option. Call option buyers risk losing their entire premium paid but nothing more. In contrast, call options sellers risk having to sell the asset if there’s a sharp increase in the asset’s price, and the buyer exercises the option to buy the asset at the lower strike price.
Call options offer high potential rewards but carry significant risks. To learn more about trading options, check out our detailed guide on how to trade options.
Frequently asked questions
How do you make money on a call option?
If you’re a buyer, you make money if the asset’s market price exceeds the strike price, with theoretically unlimited potential. If you’re the seller of the call option, your profit is limited to the premium the buyer pays.
Is it better to buy or sell call options?
While there is the potential to make money on either side, selling call options is much riskier than buying. If the share prices drop dramatically, the buyer only loses their premium. In a covered call strategy, the seller loses money from the share price depreciation.
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Written by
Lacey Stark
Lacey Stark is a freelance personal finance writer for Finder, specializing
in banking, loans, investing, estate planning, and more. She has 20
years of experience writing and editing for magazines, newspapers, and
online publications. A word nerd from childhood, Lacey officially got her
start reporting on live sporting events and moved on to cover topics
such as construction, technology, and travel before finding her niche in
personal finance. Originally from New England, she received her
bachelor’s degree from the University of Denver and completed a
postgraduate journalism program at Metropolitan State University also
in Denver. She currently lives in Chicagoland with her dog Chunk and
likes to read and play golf. See full profile
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