Scenario 3--Invest Equal Amounts of Money in Each Stock and Option then IBM Closes at $83.00. Buy a Call Conclusion: If you are sure that a stock is going to pop up a few points before the next option expiration date, it is the most profitable (and the most risky) to buy a call option with a strike price slightly higher than the current stock price. When in doubt as to whether to buy a call with a low strike price or buy a call with a higher strike price, it is always good to look at the volume that is happening in the real market and go where the volume is (I call this following the "smart money").
Now that you know how to buy a call and understand the importance of strike prices when you buy a call, the next topic addresses selling calls, also known as writing calls. When you get a quote on a stock on most sites you can also click on a link for that stock's option chain.
If YHOO is trading at $27 a share and you are looking to buy a call of the October $30 call option, the call option price is determined just like a stock--totally on a supply and demand basis. While the first 3 of these (stock price, strike price, and days to expiration) are easily agreed upon, it is the volatility and the expected volatility of the stock that traders differ in opinion and therefore drives prices.
Scenario 1--Buy 100 Shares of Stock, buy a call with a strike price of $80, buy a call with a strike price of $85, and buy a call with a strike price of $90.
If you want to be a little more conservative, you can also buy a call option with a strike price below the current stock price. If prices are random, then over a short period of time you would expect stocks to move up 33% of the time, move down 33% of the time, and stay roughly the same 33% of time. The option chain lists every actively traded call and put option that exists for that stock.
Because I think IBM will go up I want to buy a call and since option strike prices are in multiples of $5, I could buy the $80 calls, the $85 calls, or the $90 calls.
Of course, stocks don't always move the way we think, so Table 3 shows what happens if the stock price just declines a bit to $83 a share.
Notice in Table 1 that we spent $8,400 on the stock position and we spent very little on the options. Are you starting to see the attractiveness of trading options and are you ready to buy a call!
So if YHOO is trading in the $30 range, it might have strike prices of $20, $25, $30, $35, and $40.
Thirdly, you will not always find the expiration month you are looking for on the option for which you want to buy a call. Fourthly, even if you do find the option that you want to buy a call on, you need to make sure it has enough volume trading on it to provide liquidity so that you can sell it if you decide to.
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