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Buying Calls Option Strategy

The most basic option strategies involve buying calls or puts, depending on your market view.

When you are very bullish on the market, you can buy calls to profit from an upward movement that occurs while you own the option.

A call is the right, but not the obligation, to purchase an asset at a specific price (the strike price), on or before a specific date (the expiration date).

For example, suppose XXX Corp. is presently trading at $77. per share. If you expect the price to increase significantly over the next couple of months, you could purchase a call option to greatly leverage your profits from the expected movement. At present prices, you could purchase a call with a strike price of $75 and an expiration date a couple months out for about $7.50. If you are correct and XXX trades at $90. during the couple months while you are holding the option, the price of your option will more than double during that time period because the option will be priced at least $15. (anyone holding that option has the right to buy XXX at $75., but they can sell it at the current price of $90., yielding a $15. profit).

Although the underlying asset price increased less than 17%, your option on that asset increased by 100% or more. That's the leverage that options provide.

When you buy a call, your profit potential is unlimited. No matter how high the underlying asset price rises before expiration of your option, you reap the profits from that increase. Yet, your risk is limited. If the underlying asset price drops by $20, the most you can lose is the price that you paid for the option. In the example above, if Microsoft drops to $57, the most you can lose is the price you paid. In this case it would be $7.50 per controlled share.

The person who sold you the option actually holds the underlying asset, so they would absorb the rest of the loss.

When we purchase calls, we generally purchase them at-the- money or in-the-money, because it lowers our risk of losing the premium. Although out-of-the-money options are much cheaper and provide greater leverage, there is a greater risk of loss. We generally buy them several months out to provide enough time for the market to make the anticipated move.

Options are not like stocks where you buy them and hold them. Decay will continually erode your position and a change in trend can evaporate your profits quickly. It is important to set a specific target price for the option when you initiate the position. When we reach our target, we sell and take our profits. Beware that greed can be a strong motivator and make you want to increase your price target as it is rising. However, doing that can sometimes turn a winning position into a losing position.

It is important to analyze your expectations for the underlying asset and for the market before selecting your strategy.




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