Options are available on a large number of stocks, and come in two types: puts and calls. Call options give the option holder the right to buy the underlying stock at a predetermined price. The important feature of options is that each option has an expiration date, and the option buyer must exercise the contract before or on the expiration date.
1. Open a stock brokerage account with option trading privileges, or add option trading to your existing brokerage account. Stock brokerage firms require an additional application and disclosure paperwork to add options authorization to a brokerage account. A broker will give an account options privileges with a trading authorization level of one to five. A higher trading authorization allows more complex and riskier trading strategies. Buying call options can be accomplished with the basic trading authorization level.
2. Find the options chain for the stock on which you want to buy an option contract. The options chain is the list of all call and put prices for a stock, of which there will be many different choices. When you use the brokerage account screen to look up a share price, a link will be shown near the price quote for the options prices or chain.
3. Narrow your choices in the option chain screen of the selected stock. Select call options and the desired expiration month. Expirations are listed by month with available expirations for the next two months, then every three months out to about nine months. LEAPs are long term options with expirations in January of the next two years. The further out the selected expiration, the more expensive the cost of an option contract. For example, consider options on Microsoft and the LEAP option expiring in 17 months.
4. Pick a strike price for your call options contract. The strike price is the share price for the underlying stock at which you will buy the shares if you elect to exercise the option contract. The lower the strike price, the more expensive the call option will be. Continuing with the example from the previous step, assume Microsoft is currently trading at $26.50 per share. The long-term call with a strike price of $25 is quoted at $3.70 and a call with a strike of $27 is at $2.80.
5. Place an order to buy the selected call options using the option trading screen of your online brokerage account. From the option chain, if you click on the asking price of the selected option, you will be taken to the trade screen with the option information already listed. An options order is for one or more contracts. The cost of each contract is 100 times the listed price. If you have decided to buy one Microsoft option with the $27 strike price, the cost will be $270 plus commission. When the order is filled you will hold an option to buy 100 shares of Microsoft at $27 per share at any time up until the expiration date.
- The expiration day of a call option is after the close of trading on the third Friday of the listed expiration month.
- You can exercise your option at any time to buy the underlying stock at the strike price by notifying your broker.
- The value of the call option will increase as the stock price rises above the strike price of the options. You can realize any gains in the share price by selling the option contract instead of exercising the contract to obtain the shares.
- If the stock price is below the strike price at expiration, the option will expire without value. If the stock is above the strike price at expiration, the option will be automatically exercised. After exercise, the shares will be in your brokerage account and the cost of the shares will be withdrawn from your account.
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