Buying a call is one of the simplest options strategies. So how does it work, and why might a trader employ it?
First, it is important to understand that there are two kinds of options: calls and puts. A call grants its owner the right to buy a stock for a given price within a given time frame. Conversely, a put gives its owner the right to sell a stock for a given price within a time frame.
If a trader buys a call on a stock, he or she generally needs the stock to rise in order to make money. Specifically, the trader needs the stock to rise above the call's strike price by more than the price of that call option.
While buying a call and buying a stock are bullish strategies, there are some key differences. First, a call costs a certain amount of money, which is called the options premium. This premium is generally a fraction of the actual stock price, making calls more cost-effective, and offering the opportunity to make far greater percentage gains if the stock does rise.