Call option definition

Let’s say that you thought the share price of company ABC was going to increase from its current market price of CHF 20, so you decide to buy a call option with a strike price of CHF 25. For stock options, each contract is worth the equivalent of 100 shares, but the price is usually quoted for just one share.

When dealing options there is always a premium to be paid. If the premium of this option is CHF 1 per share, your total premium would be CHF 100.

If the price of ABC shares did rise, to a market price of CHF 30, you could buy that stock from the seller at the agreed-upon strike price of CHF 25 and resell it into the market for an immediate CHF 5 profit per share. This would earn you CHF 500, but you would still need to subtract your premium – meaning your overall profit would be CHF 400.

If the market moved against you, you could let the option expire and you’d only lose the initial CHF 100 premium.

Pros of call options

Call options can be opened with leverage, which allows you to get full market exposure while only having to deposit a small amount of capital.

Losses on a call option are capped at the total cost of the deposit. However, when you sell a call option, your risk is potentially unlimited because the market could continually rise.

Cons of call options

Options are susceptible to time decay, which means that the value of an out-of-the-money options contract decreases as it gets nearer to its expiry date.

Call options are complicated and could be costly for beginner traders who aren’t aware of the risks. This makes it important for traders to have a risk management strategy in place before they start trading.