Learn how to trade call options

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CALL OPTIONS

A call option is the right, but not the obligation, to buy stock (or another security) underlying the option, for a specified price, on or before a specified date.

Most people understand call options in the context of real estate.

For example, suppose you wanted to buy some land to build a house but were not ready to build the house presently. You might negotiate with the owner of the land you were interested in to give you an option to buy his land over the next six month period.

This option to purchase the land is the same thing as a call option, only it's a call option on land.

In the example above, you would pay both a price to own this call or purchase option (let's say $2,000), and then also pay the owner the purchase price of the land (let's say $250,000) if you choose to use your option and buy the land over the next six months.

If over the next six months, the housing market and the price of land collapsed, and you could in fact buy a similar piece of land for $185,000, you would not exercise the call option above, since you would not want to pay $250,000 for the land.

While you would lose the $2,000 you had paid for the call option to purchase, you could then either go into the open market and buy similar land for $185,000 (or $65,000 less), or choose simply not to buy the land in a declining real estate market.

As stated above, a call option in the securities markets is the right but not the obligation to buy stock (or another security) underlying the option, for a specified price, on or before a specified date.

An example of a stock call option presently would be an IBM August 75 call option (symbol IBMHO). This call option would give you the right but not the obligation to buy IBM stock at $75 a share until August options expiration (the third Friday of August, 2006).

IBM stock is currently trading at $77 a share. If the stock remains in value over $75 a share, you would use the call option to buy the IBM stock at $75 a share and then you could sell the stock for a profit in the open market.

Conversely if IBM stock was to fall below $75 a share at August options expiration (much like the price of land falling below in value in the example above) you would let your option expire worthless since you could go into the open market and buy IBM stock for less than $75 a share.

In the coming weeks there will be more education articles on options.