A Beginner’s Guide to Call Buying on How to Use It and How It Works

Traders buy a call option in the commodities or futures markets if they believe the underlying futures price to climb. When you buy a call option, you get the right to buy the underlying futures contract at the strike price at any moment before the contract expires. This happens infrequently, and there is no profit to doing so, so don't get too caught up in the technical meaning of buying a call option. The bulk of traders buys call options because they believe the commodities market will rise and that they will profit from it. You can also close the option before it expires, but only within market hours.

Key Takeaways

Traders acquire a call option to buy a contract at a set price.
If the price of a contract is predicted to rise, call options are typically used.
A call option is a right, not a duty, to buy the contract at a set price.
The use of call options as a stop-loss technique is also possible.

Finding the Proper Call Options To Buy

It would help if you first decided on your goals before looking for the finest purchase option. When purchasing call options, keep the following in mind:

Timeframe for which you intend to work in the industry
The maximum amount you can spend on buying a call option.
The amount of time you expect the market to move.

Most commodities and futures offer a variety of alternatives in terms of expiration months and strike prices, allowing you to choose an option that matches your needs. Every option has a finite lifespan. The futures exchange where they trade defines them by certain expiration date. Specific expiration dates for each commodity market can be found on the websites of each futures exchange.

How long do you intend to be in the call option trade?

You should buy a commodity with at least two weeks remaining on it if you expect a commodity to complete its rise higher within two weeks. This will assist you in determining the amount of time required for a call option. If you anticipate on staying in the trade for a few weeks, you should avoid buying an option with six to nine months remaining because the options will be more expensive, and you will lose some leverage. Keep in mind that in the last 30 days before expiration, the time premium of options depreciates more rapidly. As a result, you could be correct in your trade assumptions, but the option loses too much time value, and you lose money. Always buy an option with 30 days more time in the trade than you intend to be in the trade.

The Maximum Amount You Can Spend on Buying a Call Option

Some alternatives may be too expensive for you to buy, or they may not be suitable options, depending on the size of your account and your risk tolerances. Out-of-the-money call options will cost more than in-the-money call options. Also, the longer the call alternatives are available, the more they will cost. Buying an options contract, unlike futures contracts, is a cash transaction that does not require a margin. You must pay the entire option premium in advance. As a result, options in volatile markets like crude oil can cost thousands of dollars. That may not be appropriate for all options traders, and you don't want to make the mistake of purchasing deep-out-of-the-money options simply because they are within your pricing range. Most options that are well out of the money will expire worthlessly and thus are dubbed long shots.

The Market's Expected Movement Length

You should have a notion of what type of move you expect from the commodities or futures market to maximize your leverage and control your risk. Buying in-the-money options is a more conservative strategy. Buying many contracts of out-of-the-money options is a more aggressive strategy. If the market makes a significant move higher, numerous contracts of out-of-the-money options will increase your returns. It's also riskier since you risk losing the entire option premium if the market doesn't move.

Call Options vs. a Futures Contract

When you buy a call option, your losses are limited to the premium you paid for the option, plus any commissions and costs. With a futures contract, your loss potential is essentially limitless. Unless they are deep-in-the-money, call options do not move as quickly as futures contracts. This permits a commodity trader to ride out many of the market ups and downs that would compel a trader to close a futures contract to reduce risk. You must be correct not only in terms of market direction but also in terms of market timing. One of the biggest disadvantages of buying options is losing value over time. Options are a squandering of a valuable resource.

Break-Even Point on Buying Call Options

Strike Price + Option Premium Paid. Because there is no time value left on the call options, this calculation is utilized upon option expiration. Unless the options are deep in the money or far out-of-the-money, you can sell them at any moment before they expire and keep the time premium.

A Stop-Loss Instrument

A stop is a risk-reward function, and as the most successful market participants know, you should never risk more on any investment than you intend to make. Stops against risk positions are recommended for traders and investors in turbulent markets. For a short position, a call option can also be utilized as a low-risk stop-loss instrument. Stops have the drawback of causing the market to trade to a level that triggers a stop and then reverse. A long call option serves as stop-loss protection for people with short positions, but it can provide you more time than a stop that closes the position when it reaches the danger level. Because the call option serves two objectives if the option expires with time remaining and the market becomes volatile:

The call option will operate as price insurance for the short position, protecting it from further losses above the strike price.
Even if the market climbs above the guaranteed level or the strike price, the call option permits you to continue short.

Markets frequently soar only to reverse course and plummet when stop orders are triggered. The call option will keep a market player in a short position as long as the option has time until expiration, allowing them to endure a tumultuous period before the market returns to a downtrend. A short position combined with a long call is the same as a low-risk long put position. Call options are instruments that can take a direct position in a market to gamble on the price rising or to protect an existing short position from a price drop.

Frequently Asked Questions (FAQs)

How Do You Buy Call Options?

A brokerage trading account can be used to purchase an option. To trade options, you must first qualify, which may entail filling out an application that inquires about your financial situation and investing experience. You will also be asked to sign a trading agreement for options. These precautions safeguard the brokerage and guarantee that you know your trading alternatives.

What Are Call and Put Options?

Optional phone calls take advantage of rising prices by using leverage. Put options take advantage of leverage to profit from dropping prices. A put option offers you the choice, but not the duty, to sell a predetermined quantity of an underlying security at a predetermined price within a specified time frame. If you were bearish on a specific asset, you would buy put options.