In today’s investing world, many people are exploring new ways to grow their money. One of these methods involves something called options trading. In this article, we will focus on call options and how they work, especially on the popular trading app, Robinhood. We will break everything down into simple terms so that even if you’re new to investing, you can understand.
What Are Call Options?
To grasp what call options are, let’s start with the basics. A call option is a financial contract that gives the buyer the right, but not the obligation, to purchase a specific stock at a predetermined price before a certain date. This price is known as the “strike price,” and the date is called the “expiration date.”
Imagine you think a stock, like Apple, is going to rise in value. You could buy a call option instead of buying the stock outright. This means you could control the stock without needing to buy it first.
Key Terms to Know
- Strike Price: This is the price at which you can buy the stock if you exercise the option.
- Expiration Date: This is the last day you can use your option to buy the stock.
- Premium: This is the price you pay to buy the call option itself.
Why Use Call Options?
You might wonder why someone would choose call options over simply buying shares of stock. Here are a few reasons:
- Leverage: Call options allow you to control more shares with less money. Instead of spending thousands on shares, you can spend hundreds on options.
- Limited Risk: When you buy a call option, your maximum loss is limited to the premium you paid.
- Profit Potential: If the stock price goes above the strike price, you can profit significantly.
How to Buy Call Options on Robinhood
Now that we understand what call options are and why they are used, let’s go through how to buy them on Robinhood.
Step 1: Set Up Your Robinhood Account
Before you can buy call options, you need a Robinhood account. This is a straightforward process:
- Download the App: Get the Robinhood app from the App Store or Google Play.
- Create an Account: Follow the instructions to set up your account.
- Verify Your Identity: Robinhood will ask for personal information to comply with regulations.
Step 2: Get Approval for Options Trading
After creating your account, you’ll need to apply for options trading:
- Go to Your Account Settings: Find the options trading section in your account.
- Fill Out the Application: Answer questions about your trading experience and financial situation.
- Wait for Approval: Robinhood will review your application. Approval usually happens quickly.
Step 3: Find a Stock to Trade
Once approved, you can start looking for stocks to trade options on:
- Use the Search Bar: Type in the name of the company you’re interested in, like Tesla.
- Go to the Stock Page: Click on the stock to see its details.
- Select “Trade”: Click the “Trade” button and choose “Trade Options.”
Step 4: Choose Your Call Option
After selecting “Trade Options,” you’ll see a list of available options:
- Select the Expiration Date: This is the date by which you must exercise the option.
- Choose Your Strike Price: Look for a price where you think the stock will be trading before the expiration date.
- Review the Premium: This is the cost of the option. Make sure it fits within your budget.
Step 5: Place Your Order
Once you’ve made your selections, you’re ready to place your order:
- Select “Buy”: Choose the call option you want to purchase.
- Enter the Number of Contracts: Each contract typically controls 100 shares.
- Review and Submit: Double-check everything and then submit your order.
How Call Options Work in Practice
Let’s consider a practical example to illustrate how call options work.
Example Scenario
Imagine you believe that XYZ Corp, currently trading at $50 per share, will rise over the next month. You decide to buy a call option with a strike price of $55, expiring in one month, for a premium of $2 per share.
Initial Investment: If you buy one contract, it costs $200 (since one contract controls 100 shares).
Stock Price Movement: After a couple of weeks, XYZ Corp rises to $70.
Exercising the Option: You can now exercise your option to buy 100 shares at $55 each, totaling $5,500.
Selling the Shares: If you sell the shares at $70 each, you earn $7,000.
Calculating Profit: Subtracting your initial investment ($5,500 + $200 premium), your profit would be $1,300.
What If the Stock Doesn’t Rise?
Now, let’s say XYZ Corp doesn’t perform as expected. If the stock price stays below $55, you wouldn’t exercise the option. Your total loss would be the premium you paid: $200.
See Also: How Options Work in Robinhood
Risks of Trading Call Options
While call options can be lucrative, they come with risks. Here are some to keep in mind:
Time Decay: Options lose value as they approach their expiration date. If the stock doesn’t move in your favor, you might lose your entire investment.
Volatility: Stock prices can be unpredictable. Sudden drops can lead to losses.
Complexity: Options trading is more complicated than regular stock trading. It’s essential to understand what you’re doing.
Advanced Strategies with Call Options
Once you get comfortable with buying call options, you might want to explore more advanced strategies. Here are a few:
Covered Call
A covered call is when you own the underlying stock and sell a call option on it. This can generate income from the premium while still holding the stock.
Long Call Spread
In this strategy, you buy a call option at a lower strike price and sell another call option at a higher strike price. This limits your risk and reduces the cost of your position.
Conclusion
Call options can be a powerful tool for investors looking to profit from stock movements without the need for significant capital. By understanding how they work, how to trade them on Robinhood, and the associated risks, you can make informed decisions about your investment strategy.
Whether you’re new to trading or looking to expand your knowledge, mastering call options opens up new possibilities for your financial journey. Always remember to do your research and only invest money you can afford to lose. Happy trading!
Related Topic:
How To Invest To Earn Passive Income
