How does Option Buying Work?

Option Buying:

If you are planning for the purchase of stocks in share markets it can happen in this manner. In option contracts, you can derive your buying/selling options by applying option strategies to make maximum profits as per your trading plans.

Fundamentally, you will find four kinds of option strategies employed by stock exchange traders/investors. To obtain better results in the buying of stocks of the underlying assets, you can adopt option long call, option short call, and option long put in the option buying strategies. Below you will find me explaining the long call option in short.

When employing the strategies to meet your trading plans you must know the risk profiles involved while implementing the four basic options. They are ‘buying a call,’ ‘buying a put,’ ‘writing a call,’ & ‘writing a put.’ They can be described in brief.

Buying a Call:

In this case, the common notion is, the stocks will rise thereby representing a bullish trend. In such a scenario, the risk is limited to the premium paid and you can seek maximum rewards if you are involved in ‘buying a call.’

Buying a Put:

In this case, you will proceed to buy a put only when you observe a bearish outlook. Here too, the risk is limited to the premium paid, you can gain maximum rewards until the strike price of the underlying asset is less than the premium paid.

Writing a Call:

In such a situation, the stock will fall showing a bearish outlook and maximum rewards shall be limited to the premium received. When the stock price rises, you can encounter an unlimited potential risk. When a risk arises you can combine with another position to limit the risk.

Writing a Put:

You will execute a put option with a faith that the stock will have a bullish approach. In this case, the risk is unlimited to a maximum to an extent of the strike price less the premium received. You can seek a maximum reward that is limited to the premium received. You can opt to combine with another position to limit the risk.

Trading a Long Call:

Long Call is an option to buy and when you do so, you will also anticipate the underlying share price to rise.

You may prefer to buy an option contract or S&P future options, then you need to step in to purchase stocks and step out by selling those stocks to generate adequate profits.

For instance, in the NASDAQ, one contract is for 100 shares and the price of 1.00 dollar per share is applicable, therefore you will have to pay 100 dollars per contract. While in case of S&P future options, you will have to make 250 dollars for one future contract when exercised and each contract comprises 100 shares.

Step-in Long Call Trading:

You must step into a long call trading, when the stock market trend is upward, and has a support.

Step-out Long Call Trading:

You must step out, that means, sell your long options before the final month before expiration just to avoid the effects of time decay.

In case, the stock triggers down below the stop loss, then the best way to limit the loss is to sell the calls.

Stock Selection/Stock Sell-out Period:

You must select the stock that holds adequate liquidity somewhere like 500,000 average daily volume (ADV).

When selecting the option, the open interest must be from 100 onwards and 500 is preferable.

You must sell out at either the ATM (stock price equal to strike price) or ITM where the strike is below the current stock.

You must choose the option at least three months before the expiration date.