A call option is an investment product that gives the holder the right, but not the obligation, to purchase a set number of shares of the underlying security at a specific price for a specific period of time. One call option typically controls 100 shares of the underlying stock. The premium, or price, for a call option results from a combination of the option's intrinsic value and time value.
1. Determine the current price of the underlying stock and compare the stock price to the strike price of the call option. The strike price is the price at which the option can be exercised, or the price at which you can buy the underlying stock. If the price of the stock is above the strike price, the call option is said to be in the money. If the price of the stock is the same as the strike price the call option is said to be at the money. If the price of the stock is below the strike price the call option is said to be out of the money.
2. Determine the current market price for the call option. If the option is in the money, subtract the strike price from the current market price. The remainder is the intrinsic value of your call option. Once a call option is in the money, the intrinsic value of the option will move in tandem with the market price of the underlying stock.
3. Subtract the inherent value of a call option that is in the money from its market value. The remainder is the time value of the call option.
4. Determine the current market price for the call option. If the call option is at the money or out of the money, the option has no intrinsic value. The entire market price for a call option that is at the money or out of the money consists of its time value.
- The tendency of a call option to lose time value as it approaches its expiration date is known as time decay. The rate of decay increases as the nears its expiration date.
- The profit potential from buying call options is unlimited, as the value of an in the money option increases along with increases in the underlying stock.
- The investor's potential loss is limited to the premium paid for the option, regardless of how much the price of the underlying stock may decrease.
- Options trading is a sophisticated investment technique that is not appropriate for all investors. Investors may lose some or all of their investment.
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