Call Options Explained for Beginners

what's going on YouTube my name is Chris from Project option and in today's video I'm going to explain to you call options in great detail so be sure to stick with me in this video I'm going to explain to you buying call options as well as selling call options and I'm going to do that by intuitively explaining to you how call options get their value how each strategy works in terms of buying call options and selling call options and I'm going to do that by showing you numerous historical trade examples so you can see exactly how buying call options and selling call options make and lose money as trading strategies I'm also going to enter real call option trades using the Tastee works brokerage software so you can see exactly what it looks like to go through the motions and actually make a call option trade using real trading software to first explain to you what a call option is I'm going to explain it from the perspective of a call option buyer in the most common explanation a call option is described as a contract that allows the option buyer to purchase 100 shares of stock at the call options strike price at or before that option expires in options trading a strike price is the price at which the option can be converted into shares of stock and therefore where a transaction will take place if the option is exercised for example if a call option has a strike price of 105 dollars and that call option is exercised the call option buyer will purchase a hundred shares of stock at $105 per share which is the call options strike price so a strike price is simply the price at which shares will be traded should the option be exercised as an example let's say we're looking at a call option on Apple with a strike price of $200 in an expiration date of October 2019 let's say this option is currently trading for a price of $13.50 if a trader buys the 200 call option an apple that expires in October 2019 and they pay $13.50 for that option this means that the trader has the ability to buy 100 shares of Apple stock at $200 per share before the option reaches his expiration date which in this example is 63 days away there are two basic concepts that you need to understand here before we move forward the first basic option concept that you need to internalize here is that options are quoted on a per share basis and a standard option such as an option on Apple can be converted into 100 shares of stock all this means is that we need to convert the options quoted price into its actual value by multiplying the options price by the option contract multiplier of 100 this means if a trader purchases the Apple call option for its quoted price of $13.50 that trader actually needs one thousand three hundred and fifty dollars to purchase that option because the option is actually worth thirteen hundred and fifty dollars since we have to take its quoted price of $13.50 and multiply it by the option contract multiplier or how many shares that option can be converted into which is 100 so if we take $13.50 and multiply that by 100 we get the options actual value in dollars of thirteen hundred and fifty dollars as another example if I'm looking at options on spy and I see an option quoted at three dollars and 16 cents I know that option is actually worth three hundred and sixteen dollars because I have to take that quoted price of three dollars and sixteen cents and multiply it by the option contract multiplier of 100 to get an actual option value of three hundred and sixteen dollars the second and perhaps the most critical concept that you need to understand about call options is that a call options value is directly tied to its strike price what I mean by that is since the call option buyer can purchase shares of stock at the call options strike price that call option is going to become more and more valuable as the stock price increases further and further above that called strike price because the higher the stock price gets relative to the call options strike price the call buyer now has a bigger advantage of owning that call option because since that call options strike price is fixed and they can purchase shares of stock at the call options strike price that means that if the stock price continues to increase that call options value will also increase because that call option is literally becoming more valley because its ability to purchase shares of stock at the call options fixed strike price is getting more and more advantageous as the share price increases because the call option buyer can buy the shares of stock at a deeper discount relative to the current share price if I own an apple call option with a strike price of $200 an apples share price is at 220 dollars my 200 call option is going to be worth at least $20 or $2,000 in value when we account for the option contract multiplier because my 200 call option can purchase a hundred shares of Apple stock $20 below the current share price of two hundred and twenty dollars and that means the call options value has to be worth at least $20 since the value in buying shares of Apple stock $20 below the current share price is worth at least $20 per share when the stock price is above a call option strike price the call option has intrinsic value intrinsic value is simply the difference between the stock price and the call options strike price so intrinsic value can literally be interpreted as the benefit or value associated with buying shares of stock at the call options strike price as opposed to buying shares of stock at the current share price as another example if Apple is trading at 235 dollars that same 200 call option that I was discussing earlier now has 35 dollars of intrinsic value because with Apple stock at 235 dollars that 200 call option can be converted into 100 shares of stock at $200 per share which has a value of $35 at a bare minimum since Apple's current share price is 235 dollars in options trading it is a law that options will be worth at least their amount of intrinsic value otherwise there's an arbitrage opportunity or an opportunity to make a risk-free profit with this in mind how do call option buyers actually make money on a trade the goal when buying a call option is to sell the call option at a later date for a higher price so just like when you're investing in a share of stock you're adopting a buy low sell high mentality where your goal when buying a share of stock is to sell it at a later date for a higher price therefore realizing a gain on your purchase into the shares of stock it's the same thing with options and when you're buying a call option you want to see the call options value increase in the future and therefore you will have the opportunity to sell that call option at a higher price and therefore you will realize the profit on that transaction knowing what we just discussed about a call options value being directly tied to its strengths price and where that strike price is relative to the stock price since a call options value is tied to its ability to purchase shares of stock at the call options strike price as opposed to the current share price it makes sense then that when you buy a call option you want the stock price to increase as far as possible above that call options strike price as that call option will become more and more valuable as the share price increases because the benefit of buying shares at the call options strike price that you own becomes more and more valuable as the share price gets to a higher price relative to the call options strike price a lot of prices there I know bear with me so getting back to our examples if I buy a call option on Apple with a strike price of $200 and Apple is currently trading for two hundred and twenty dollars I know that call option is going to be worth at least twenty dollars since the call options strike price is exactly $20 below the current share price of two hundred and twenty dollars if that call option is worth at least $20 we know that that actual valuation comes out to two thousand dollars when we multiply it by the option contract multiplier now let's say a few weeks pass an apple stock price increases to two hundred and forty dollars knowing what we know about call options since the call options strike price is $200 and Apple stock price is now two hundred and forty dollars which is $40 above the strike price of two hundred dollars we know that that 200 call option is now going to be worth at least $40 or having a valuation of $4,000 when we account for the option contract multiplier and if I calculate the profit on that trade if I purchase the call option when it was $20 I had to pay $2,000 for that call option if Apple stock price increases to 240 dollars my 200 call option is worth at least $40 now and when we multiply by the option contract multiplier of 100 we get a valuation on that option of $4,000 so if I bought the option for $2,000 and an increased to $4,000 through Apple stock price increase I could go ahead and sell that call option for $4,000 realizing a $2,000 gain on a $2,000 investment which would be a 100% return on the money that I put into that call option because of the immense reward potential and limited risk buying call options is a very attractive strategy in terms of risk to reward so now we have to shift gears and talk about how call option buyers actually lose money since that's the more likely scenario that you're going to encounter when you purchase call options we just discussed how I call options value will increase as the stock price continues to increase further and further above the call options strike price because the benefit of buying shares of stock at the call options strike price as opposed to the current market price of the shares gets more and more valuable as the stock price increases now with that being said it makes sense then that a call options value will decrease if the stock price also decreases because if the stock price decreases that call option has less value because there is less benefit in buying shares of stock at the call options strike price since the share price has just decreased from where it used to be and therefore there's less of a benefit of using that call option to buy shares of stock since the share price is now closer to that call option strike price to demonstrate what I mean by this let's say I own a call option on Apple with a strike price of 175 dollars and Apple is at $200 per share based on this we know that this 175 call option has to be worth at least $25 or $2,500 when we account for the option contract multiplier and that's because the share price is $25 above that call option strike price of 175 dollars now let's say unfortunately Apple share price decreases and a few weeks later Apple share price is now at 180 dollars since I own the call option with a strike price of 175 dollars since Apple's share price is 180 dollars this call option only has to be worth five dollars and since it used to be worth $25 or 2500 dollars in actual value but now the share price is now lower and closer to the call option strike price and the call options value is now only $5 I have lost $2,000 on this call option trade so with this being said the most straightforward way that you can lose money when buying a call option is to see the share price decrease after you've purchased the call option if you buy a call option and the share price decreases that call option becomes less valuable because if the stock price is above the call strike price and the share price decreases the benefit of using that call option to purchase shares at the strike price as opposed to the market price of the shares has now decreased because the share price is at a smaller premium to the strike price relative to what it used to be the second way a call option buyer can lose money is through the decrease in the options extrinsic value as time passes which was referred to as time decay or extrinsic value decay so I already explained to you what intrinsic value is for call options but let me explain what extrinsic value is if we go back to the Apple call option example from earlier I mentioned that the 200 call option expiring in 63 days was trading for $13.50 however Apple stock price at that time was only two hundred and six dollars and ten cents which means that two hundred call option on Apple only had six dollars and ten cents of intrinsic value however we can see that the option was trading for $13.50 so what is the additional value above the intrinsic value well an options value above its intrinsic value is referred to as extrinsic value or time value this is critically important to understand because at an options expiration date the option will only be worth the amount of its intrinsic value if as time passes and as an option approaches its expiration date the options extrinsic value will slowly wither away leaving only the options intrinsic value if any at expiration that means that at expiration in 63 days if Apple is still at 206 dollars and 10 cents the 200 call option will only be worth six dollars and ten cents because with the stock price at 206 dollars and ten cents and the strike price being $200 the 200 call option only has six dollars in 10 cents of intrinsic value and with the option price currently being $13.50 with 63 days to expiration if we were to plot the option price over time and assuming that Apple stayed right at 206 dollars and 10 cents that $13 and 50-cent call option would slowly decrease to a $6 and 10 cent call option at expiration in 63 days since that call option only has six dollars in 10 cents of intrinsic value if I bought this call option for $13.50 and it expired with a value of six dollars and ten cents assuming I sold the option before it expired and I sold the option for six dollars and ten cents I would have a loss of seven dollars and 40 cents on that option transaction and that means if I account for the option contract multiplier of 100 my loss would be seven hundred and forty dollars for every call option that I purchased for $13.50 and sold for six dollars and ten cents you might be wondering why an option would have extrinsic value or why the option would be worth more than its intrinsic value or the value associated with buying shares of stock at the strike price relative to the current share price and the answer is that extrinsic value is usually referred to as time value and it's referred to as time value because extrinsic value can be interpreted as the value of an option contract that is associated with it becoming more valuable before it reaches expiration so in the case of this 200 call option on Apple that has 63 days left until expiration there are 63 days left for Apple stock price to increase significantly and therefore the call option would become much more valuable than it is now with the stock price only at 206 dollars and ten cents so options with more time until expiration will trade with lots of extrinsic or time value because there's lots more time left for the stock price to increase in the favour of that call option and therefore there's lots of time left for that call option to become immensely more valuable and that is why if you look at an option with lots of time until expiration it will be trading with lots of extrinsic value relative to an option at the same exact strike price that has maybe just a day or a couple weeks until expiration what this means for you as an option buyer is that when you buy an option since you have a limited amount of time before the option expires and as the option approaches its expiration date the extrinsic value will come out of that option when you buy an option you need to be correct about the direction of the stock price movement and you also need to be correct about the timing that that stock price movement occurs in otherwise your position will lose money from the decrease in extrinsic value as time passes so instead of continuing to talk about the theory let me go ahead and show you some actual historical call option purchases and I'm going to plot the performance and the price of those call options relative to changes in the stock price so that you can see exactly how the call option trade performed as the stock price changed and as time passed in this first example a call option with a strike price of 105 dollars and 31 days to expiration is purchased for three dollars and 40 cents that means the maximum loss potential of this call option purchase is three hundred and forty dollars per contract that is purchased since we discussed earlier that if a contract is quoted at 3.40 cents we have to multiply that option value by the option contract multiplier of 100 to get its actual value of three hundred and forty dollars the break-even price of this call option purchase is 108 dollars and 40 cents and I arrive at that breakeven price by adding the premium that I paid for the call option which is 3.14 to the strike price of 105 dollars if I add one hundred and five dollars and three dollars and 40 cents I get a breakeven price on this call option purchase of 108 dollars and 40 cents that means that at expiration if the stock price is exactly at 108 dollars and 40 cents we know that this call option will be trading with three dollars and 40 cents of intrinsic value and we also know that at expiration an option will only consist of intrinsic value and therefore if the stock price in this case is right at 108 dollars and 40 cents at expiration the 105 call option will be worth three dollars and 40 cents and since that's the exact same price I paid for this option I will not have a profit or loss on this trade if the stock price is exactly at 108 dollars and 40 cents at the time of expiration in 31 days early on in this trade we can see that the stock price increases very quickly to a price of about 108 dollars and with the quick increase in the stock price right after purchasing this 105 call option we can see that the value of the 105 call option also increases to a price of about five dollars at an option price of five dollars if a trader purchased this call option initially for three dollars and 40 cents they would have an unrealized profit of one hundred and sixty dollars per call option that they purchased since they initially paid three hundred and forty dollars for the option but with the option price now at five dollars that means the options value is five hundred dollars and if an option goes from three hundred and forty dollars in value to five hundred dollars in value that means the option price has increased by one hundred and sixty dollars at this time in the trade if the trader wanted to exit this position for a profit of one hundred and sixty dollars all they would have to do is sell the call option for its current market price of five dollars and by doing so they would realize the profit of one hundred and sixty dollars per call contract but of course there's no knowing when the stock price is going to decrease and in this instance let's say the trader thought the stock brace was going to continue to increase so they stayed in the trade unfortunately we can see that the stock price hovered around the strike price of 105 dollars for the entire duration of the trade and at expiration the stock price was actually below the call strike price of 105 dollars at which point the option had no value at all because at expiration if the call options strike price is above the current share price that means a trader could simply buy shares in the open market at the lower share price and they don't need to buy shares of stock at the call options strike price which means the call option has no value at all at expiration because it has no intrinsic value this example illustrates time decay very nicely because as we can see here as the stock price is remaining near the call options strike price as time passes and as the option gets closer to its expiration date we can see that the call options value steadily loses value as it becomes more and more certain that the option will not be immensely valuable before it expires because as time passes without an increase in the stock price the stock price has less time to increase in favour of the call option and that means there's a lower probability that this call option will be significantly more valuable than it is now before it expires let's go ahead and look at another example but this time we're gonna look at a call option purchase that makes a lot of money in this example a call option with a strike price of $92.50 and 42 days to expiration is purchase for a price of $4 and 65 cents which gives this trade a breakeven price of ninety seven dollars and 15 cents as we can see here the stock price increases steadily over the entire trade duration and is well above the break-even price of ninety seven dollars and 15 cents at the time of expiration at expiration the stock price is around 106 dollars which means the 9250 call option has about $13.50 of intrinsic value now that's because at 106 dollars the 9250 call option has the ability to purchase 100 shares of stock at 92 dollars and 50 cents which is exactly $13.50 lower than the current share price of 106 dollars because of that at expiration this call option is trading with a value of around $13.50 which we know when we account for the option contract multiplier of 100 gives us an actual call option value of 1,350 dollars with an initial purchase price of four dollars and sixty five cents and the option price increasing to $13.50 by expiration the profit on this trade would be eight hundred and eighty five dollars for every call option that was purchased for four dollars and sixty five cents and sold for $13.50 at expiration in eight hundred and eighty five dollar gain on a four hundred and sixty five dollar initial investment means that the trade in this example had a return of one hundred and ninety percent on the initial amount invested into this call option this example beautifully demonstrates why buying call options is such an attractive strategy as if the stock price increases steadily over the duration of the trade the call option purchase can make lots of money relative to what was invested and in this example the call option purchase made one hundred and ninety percent relative to the amount that was initially invested into the option at the beginning of the trade now on the other hand if the stock price were to have fallen the maximum lost potential of this trade is four hundred and sixty five dollars for every call option that is purchased since if a trader buys a call option for four dollars and sixty five cents that means they actually paid four hundred and sixty five dollars for that option and therefore the maximum loss potential is four hundred and sixty five dollars so in this case the ability to make eight hundred and eighty five dollars relative to the maximum loss potential of four hundred and sixty-five dollars shows why buying call options is such an attractive strategy in terms of the potential risk and potential reward now as I promised earlier I'm going to actually show you what it looks like when you buy a call option using real brokerage software and for this I'm gonna hop onto the tasty works brokerage platform and I'm going to show you what it actually looks like to go through the motions and purchase a call option and I'm also going to show you how the OP are quoted and how that translates to an actual dollar amount or cost for entering a call option purchase be sure to check the link down in the description to learn more about tasty works and their commission rates and to learn about our standing offer of providing you access to one of our paid options trading courses when you open and fund your first tasty works brokerage account and you use the project option referral code when you open your account if you've been watching my videos and you enjoy my channel opening an account with tasty works and using the referral code is a great way to say thank you as it helps support me in the channel alright so I've just opened up the tasty works trading platform and really quickly if you're unfamiliar with tasty works on the left hand side I have a watch list which just shows some of the symbols and stocks that I'm watching on a daily basis and this is a pretty short list because I don't watch too many things on the top left here we have this search box and right now I have entered Apple into the search box and apples ticker symbol is AAPL and with apples information entered all of this information is related to Apple's stock so we can see that Apple is currently trading for two hundred and fifty six dollars and fifty one cents and I've currently got to open the chart tab to show apples recent stock price movements so we can visualize what's been going on so as we can see here Apple has been on a significant rally over the past few months and let's say I wanted to play into this momentum and put on a bullish position in an option and therefore one of the things I might look at is buying a call option to go ahead and look at what I can do I have to first go to the trade tab and the trade tab can be accessed by clicking right here on this trade tab and once I do that this opens up the option chain for Apple and right now I can see all of the different expiration cycles that I can choose from and in the middle where it says strike this is actually the number of days until each of these expirations has before they expire so 44d means that it has 44 days until expiration I'm going to go ahead and open up the January 2020 options with 72 days until expiration so all I have to do is click on January 2020 and this will drop down the options in the G January expiration cycle and all of these call options and put options have 72 days until expiration on the left hand side we have two call options and we can see we have a bid price and we have an asking price if you're unfamiliar with the bid price and the ask price the bid price is the highest price someone is willing to pay for that option in the asking price is the lowest price someone is willing to accept for selling that option so in this example I'm gonna go ahead and look at the 250 strike price call option as we can see here the bid price is 13.5 cents and the asking price is $13.20 which gives us a mid price or a midpoint between these two prices of thirteen dollars and fifteen cents currently so if I want to buy this at 250 call option I am going to click on the asking price since the asking price is the lowest price someone is willing to accept for selling that option and on a trading platform particularly tasty works to initiate a purchase order you're going to click on the asking price of that option and I can see that this is queuing up in order to buy this option based on the green box that has been placed around the strike price and call option and on the left hand side it says b1 this is telling me I'm trying to buy one contract of this call option on the bottom here we have this price indicator and I can go ahead and change my order price with these arrows and I'm not going to be able to choose necessarily whatever price I want because I have to operate within this bid and ask price and typically you want to try to purchase or sell an option at the mid price and if you can't get filled then you adjust your price slightly out of your favor so for buying an option if I can't get filled at the mid price which is currently 13 dollars and 15 cents then I would have to try and buy this option for slightly more than 13 dollars and 15 cents and I would just have to just keep adjusting the order from there until I got filled so as I mentioned earlier in this video this option is being quoted at around 13 dollars and 15 cents and that means I actually need times that to purchase this option so if we go to the maximum loss right here we can see that the maximum loss if I purchase this option for thirteen dollars and fifteen cents is a maximum loss of one thousand three hundred and fifteen dollars now that's because if I purchase this option for thirteen dollars and fifteen cents I actually need a hundred times that to purchase the option and my maximum loss when purchasing an option is whatever I pay for that option so if I go ahead and click review and send this will show me additional information and will allow me to review everything before I actually execute the order and try to get filled so as we can see here I'm trying to buy this option for thirteen dollars and fifteen cents and the estimated trade cost is shown as one thousand three hundred and fifteen dollars now that's a debit or dB which means I am paying to enter this position if we add the Commission's and the estimated fees and then I get a total trade cost of one thousand three hundred and sixteen dollars and fourteen cents and that is how much money I need in my account to actually execute this order so I'm gonna go ahead and actually try to buy this call option for thirteen dollars and fifteen cents and since that's actually a little higher than the mid price in this particular moment I'm assuming that I'm gonna get filled instantaneously on this order so let's go ahead and see what happens so I was not filled immediately and that's because right when I did that well actually there we go so I just got filled at thirteen dollars and fifteen cents and now I own a two hundred and fifty call option in Apple that expires in 72 days so to actually go and see that position I just go to the positions tab and we can see that I have a position in Apple and I can just click on Apple to drop that down and this shows me that I own one call option expiring in January and that has 72 days until expiration the strike price is 250 and this says C which indicates that this is a call option that I am trading so we can see the trade price is a negative 13/15 and that means that I paid $13 and 50 to enter this position the mark or the current marked price of this option is $13 in ten cents in this current moment and therefore it's giving me an open p/l of a loss of a few dollars so basically the difference between the trade price and the mark price is showing me that I have currently lost three dollars on this position now five dollars because the mark is a little bit lower than what I paid for the option if the option price increase from my trade price this PNL open would be a positive number because the PNL open is just showing me how much money i have made or loss on this position since opening the trade hence P and L open so I'm gonna go ahead and close this position just to show you how easy it is to close an option trade and you might already be wondering and it's a very common question I get because this option has 72 days until expiration do I have to hold the position for 72 days until it expires the answer is no I can close this position whenever I want and all I have to do since I entered this trade by purchasing the option I just have to sell this option at whatever price I can get and I will lock in the current profit or loss based on that price so once I've clicked on this option and it is highlighted I can right-click it go to closed position and this cubes up in order to potentially sell this call option and I know it's a sell order because it placed a red box that says s1 around the 250 strike price and call option so this is just telling me that I'm trying to sell one of these call options but I have not executed the order yet because I need to select my price and then review and send the order and then finally confirm all the details and send it to the exchanges to see if I can get filled so I'm gonna go ahead and try to sell this for $13.10 since the bid price is 1305 and the asking price is 1315 so I'm going to go ahead and review and send my price of $13 and ten cents is selected and I'm gonna go ahead and click send order so I got filled instantaneously and therefore I lost a I lost $5 on this trade because I initially purchased the option for $13.50 means I paid one thousand three hundred and fifteen dollars for the option but I just sold it for $13 in ten cents which means I received one thousand three hundred and ten dollars for selling the option and the difference between those two prices was a $5 loss so hopefully this was helpful in demonstrating to you how easy it is to go ahead and purchase a call option and more importantly how easy it is to close an option position that you've entered so now that we've talked about buying call options and I've shown you what it looks like to actually make a call option purchase using the tasty works brokerage software let's switch gears completely and talk about selling call options as a trading strategy when selling or shorting call options you adopt a sell high buy low mentality now because of that when you short call options you want the stock price to decrease because if the stock price decreases the value of the call option that you've shorted will decrease as well and that will give you an unrealized profit since if you sell a call option here and the call options price Falls to here you will have an unrealized gain on that trade at which point you can buy back the call option closing the position and realizing the gain that you have at that moment let's go ahead and look at some actual trade examples from history and see how selling call options works as a trading strategy and how it makes and loses money in this first example a trader shorts a call option with a strike price of 105 dollars 31 days to expiration and they sell this call option for 3 dollars and 40 cents this gives the short call trader a breakeven price of 108 dollars and 40 cents because if the stock price is right at 108 dollars and 40 cents at expiration the option price with a strike price of 105 dollars will be worth three dollars and 40 cents and if I short a call option for 3 dollars and 40 cents and it is worth 3 dollars and 40 cents at expiration I will not have a profit or loss on that trade which means I break even if the stock price is less than 108 dollars and 40 cents at expiration the 105 call will be less than three dollars and 40 cents and that means as a short call trader who wants the option price to decrease I will have a profit on my trade if the stock price is at any price below 108 dollars and 40 cents at expiration in 31 days in this example the stock price never increases to significantly and actually trades around the strike price of 105 dollars for almost the entire trade duration and as we can see since the stock price was not increasing significantly as time passed the extrinsic value slowly came out of that 105 call option and at expiration with a stock price below the strike price of 105 dollars the 105 call option expired worthless which means as a short call trader if I sell a call option for 3 dollars and 40 cents and it expires with a value of $0 I keep the 340 dollar premium that I make from that transaction since if I sell something for 3 dollars and 40 cents and I buy it back for 0 dollars or it expires with a value of $0 I will make 3 dollars and 40 cents on that option trade and when I multiply that by the option contract multiplier of 100 I get a profit on the trade of 340 dollars for every call option that I shorted selling call options is a very high probability strategy because as we've discussed in this video as long as the stock price is not increasing with the passage of time the call options value will slowly decrease as the extrinsic value comes out of that option in theory when selling call options the probability of making money is greater than 50% but we need to keep in mind that the high probability of making money is due to the fact that when you sell call options you have limited profit potential because the option price can only go to $0 which means your maximum profit potential is the difference between your sale price and $0 but since there's no limit to how much a stock's price can increase there's also no limit to how much that call options price can increase and therefore when you're selling call options as a strategy you have unlimited loss potential in theory because of that you're going to have a significant margin requirement meaning that in the example of selling this 105 call option for 3 dollars forty cents it's likely that I'll have to put up a few thousand dollars in margin to open that position because of the fact that there is such immense loss potential if the stock price were to increase significantly to demonstrate exactly what I mean by this let's look at an example of a short call trade that ends disastrously as the stock price increased significantly in this example a call option with a strike price of $60 and forty three days to expiration is shorted for two dollars and 28 cents which gives this trade a breakeven price of sixty two dollars and twenty eight cents since this call option is sold for two dollars and twenty eight cents the maximum profit on this trade is two hundred and twenty-eight dollars since if the option is sold for two dollars and twenty eight cents and the option price it goes to zero dollars or the option expires worthless the profit on that trade will be two hundred and twenty-eight dollars as I discussed earlier selling a call option all by itself has unlimited lost potential in theory so there is no way to calculate a maximum loss potential for this particular trade unfortunately the stock price in this example gapped significantly higher on one of the trading days and was about thirty dollars above the call options strike price at the time of expiration knowing what we know about call options if the stock price is thirty dollars above the call options strike price the call option is going to be worth at least thirty dollars with an initial sale price of two dollars and 28 cents an increase in the call options value to thirty dollars represents a loss of two thousand seven hundred and seventy two dollars for every single call option that was sold for two dollars and twenty eight cents and later closed for thirty dollars the fact that this trade lost almost three thousand dollars per call contract but only had a maximum profit potential of two hundred and twenty eight dollars per call contract sold illustrates why selling call options all by themselves is an immensely risky strategy that I personally would never recommend especially if you're just getting into options trading really quickly I'm going to use the taste of works trading platform to show you what it looks like to go through the motions and short a call option and also show you what the marginal it would be for the call option that I'm going to sell in this example alright so as promised now I'm going to show you what it looks like to go ahead and sell a call option as an opening trade so in other words shorting a call option so this is confusing for most because you wonder how you can sell something without initially owning it first but in trading that is called shorting so just like buying a share of stock and trying to sell it at a higher price you can actually do the opposite and you can short a share of stock with the intention of buying back or closing that share position at a lower price therefore pocketing the difference so instead of buying low and trying to sell high you can sell high and ideally buy lower so with options that is called shorting an option and you can do so by initiating a sell order on an option that you do not already own so right now I'm looking at SP Y which is the S&P 500 ETF and currently SP Y is trading just under three hundred and seven dollars we can see that the SP 500 has rallied pretty significantly recently and let's say I am a bearish trader who thinks that the stock market is going to decrease in the near future and I want to take advantage of that by selling a call option so one thing I'm gonna look at is selling this 310 call option so right now SP Y is at 307 but I can sell a call option with a strike price above the current stock market or above the current price of spie and by doing so I will sell a call option that consists of 100% extrinsic value and as we discussed earlier as time passes extrinsic value comes out of an option and at expiration as long as SP Y is below 310 dollars that call that I sold with a strike price of 310 dollars will expire worthless and I will keep the maximum profit potential so to go ahead and look at what these options are actually trading for I'm gonna yet again go back to the trade tab by clicking on this trade tab right here and this will bring up the option chain for spy since I have SP Y entered into the search box which means all of the information on the platform will be showing me the information related to spy so I'm gonna go ahead and look at the December 2019 with 44 days until expiration I'm going to click on this expiration which will show me the options and on the left hand side we have the call options and in the middle here we have the strike prices so I mentioned I was going to look at selling the 310 call option so earlier I mentioned that the bid price as the highest price someone is willing to pay for an option and the asking price is the lowest price someone is willing to accept for selling an option so when you want to initiate a sell order to sell an option you're going to click on the bid price so if I click on the bid price of the 310 call option that is going to queue up a sell order to potentially sell this call option and I know that because it puts a red box around the 310 call option and it says s1 which means I'm trying to potentially sell one contract of this call option we can see that the bid price is three dollars and forty-five cents and the asking price is three dollars and 47 cents but as I said earlier but as I said earlier these prices are going to change as the stock price changes and as the market demand and supply for these options also changes so these prices are going to bounce around but I'm gonna actually try to enter an order based on whatever I'm seeing so right now if I tried to sell this option for three dollars and 46 cents the first thing I want to mention is that knowing that we have to multiply this quoted price by 100 to get the options actual value if I take this $3 and 46 and option price and multiply that by 100 I get three hundred and forty six dollars right here under maximum profit potential it shows three hundred and forty seven and that's because the price just changed to three dollars and forty seven cents but if I sell this option for three dollars and forty seven cents and it goes to zero dollars I will have a three dollar and forty seven cent profit on this option trade since I sold it for three dollars and forty seven cents and if it expires worthless then I will keep the entire premium that I've sold the option for initially so if I sell this option for three dollars and forty seven cents I am actually going to collect three hundred and forty seven dollars in premium because we have to account for the option contract multiplier of 100 that I discussed earlier so if I click review and send we can see that it gives me the estimated trade cost of 347 and there's a green CR next to this which means credit and that means that I'm going to collect three hundred and forty-seven dollars in my account for selling this option for three hundred and forty seven dollars if we add the Commission's and the estimated fees the net credit that I receive is three hundred and forty five dollars and eighty five cents so if I sell this option after commissions and fees I will collect three hundred and forty-five dollars and 85 cents into my account now at a later date if I buy back this option for a lower price let's say I buy it back for two dollars meaning I would have to pay two hundred dollars in premium to close this option my profit on this trade will be the difference between what I collected for it initially and what I've paid for it to close the trade and if this option actually expires worthless then my closing price would be zero dollars in which case my profit on this trade would be the full three hundred and forty five dollars in 85 cents that I'm going to collect when entering this trade right now the estimated buying power effect is something that I mentioned earlier and this is the margin requirement so this is the amount of money I have to put up in my account to actually enter this trade now I mentioned selling call options is a highly risky strategy because if you sell a call option there is theoretically no limit to how much the stock price can increase which means selling a call option all by itself has in theory unlimited loss potential which means I'm going to have to put up a significant margin requirement to account for the potential losses that I could encounter should the stock price increase substantially so in this case the estimated buying power effect is just under $6,000 now that means for me to sell this call option just one contract of it and collect three hundred and forty five dollars and 85 cents I need to have $6,000 in available margin in my account to actually sell this option so that means I would have to have $6,000 of available cash in my account to actually sell this option so let's say everything looks good and I want to go ahead and sell this option for three dollars and forty-five cents since that's the actual bid price well actually now it's the asking price let's go ahead and see if I can get filled out 3:45 it might take a second but I'm gonna hit review and send and then send order and I was filled instantaneously and to go ahead and confirm this we can see that there's a negative one around the bid price for this 310 call option and that is the platform's way of saying that I have a position and I sold one contract of this 310 call option and I can go ahead and go back to my positions tab open up the s py option and this shows me that I have sold one 310 call option in s py with an expiration 44 days away and that is the December 2019 expiration cycle so we can see that the trade price is 345 which means I sold this position for three dollars and 45 cents and currently we can see my P&L open is zero dollars actually now negative one dollars because I sold this position for three dollars and forty-five cents but the current market price of the option is three dollars and 46 cents which is one dollar higher then I sold the option for initially so this P&L open is just showing me how much money I've made or lost since opening this short call position so now I want to go ahead and actually close this position because I do not want to hold it so I'm going to go ahead and click on this option right click hit closed position and this is going to queue up an order to purchase this 310 call option which is the exact opposite thing I did to get into this trade and that is how you close any option position you just have to enter the exact opposite trade that you used when entering the position in the first place so right now I'm gonna go ahead and look at the prices the bid price is 346 the asking price is 347 if I try to buy this call option for $3 and 47 cents I will be filled immediately but I'm gonna go ahead and try to buy it at 346 just so I can only lose one dollar on this trade as opposed to two dollars so actually it's changed now so if I buy this option for 346 I will realize a $1 loss and I'm gonna actually try to get out at 345 so I'm gonna review and send send order and I'm not getting filled yet because the bid price is 345 and typically if you're buying an option you will not be able to buy right at the bid price I will get filled however if I change it to 346 which I can do by going back to the positions tab right clicking on my working order hit replace order increase the price to 346 hit review and send send order but yet again the price has increased again and now the bid price is 346 and the asking price is 348 so I'm not going to get filled in this trade just yet so I'm gonna do that one more time and change it to 347 see if I can get filled and I'm not yet filled because this price is steadily increasing incrementally against me so it's making it hard for me to get filled on this trade so I'm gonna do that one more time go to 348 hit review and send send order and now I've gotten out of that trade because that was the asking price and when you try to buy an option you will typically always be able to get into that trade if you buy right at the asking price but it's advisable to start at the mid-price and then work slowly out of your favor so that you can get the best possible price for you but since in this video I was just trying to demonstrate how easy it is to get in and out of an option trade I'm not really too concerned about the small loss that I took on this because I wanted to demonstrate to you guys how easy it is to enter an option trade and then get out of that option trade despite having been in the trade for only a couple minutes so I hope this was helpful as an alternative to buying call options by themselves or selling call options by themselves traders will either buy a call spread or sell a call spread which will help with some of the downsides that I've discussed in this video related to buying call options by themselves or selling call options by themselves but I'm not going to explain the spread strategies in this video as I've created entirely specific videos for buying call spreads and selling call spreads so if you want to learn about those spread strategies be sure to check the links down in the description so you can watch the videos on each of those respective option strategies if you enjoyed this video I would greatly appreciate if you gave it a light and if you shared it with somebody that you think would benefit from the content that I've discussed in this video I'd also love to hear your thoughts on this video so be sure to leave me a comment down below and I will respond to you as soon as I can my name is Chris from Project option and I will see you in the next one [Music]

Channel: projectfinance

Views: 167,643

Rating: 4.9021406 out of 5

Keywords: call options, call options explained, call option basics, call option, call option intrinsic value, buying call options, selling call options, call option trade example, trade examples, tastyworks, short call option explained, short call option example, long call option explained, long call option example, projectoption, call strike price, call options example, options trading

Id: fUZHmJAvN30

Length: 51min 36sec (3096 seconds)

Published: Fri Nov 08 2019