Buying a Call

Buying a call is considered a bullish strategy. This strategy has unlimited profit potential with limited risk. With this strategy, the buyer is assuming there will be a rise in the underlying in the near term. The strategy can also be used to provide leverage on the underlying.

Unlimited profit potential: Since the call gives the buyer the right to purchase the stock at strike price, no matter the current price of the stock, the buyer's potential profit is unlimited.

Limited risk: With this strategy, the buyer can only lose the premium paid for the underlying. Although it has limited risk, on a percentage basis it is considered very risky. The reason is that 100% of the investment is at risk. This could be lost with a relatively small movement in the stock.

Break-even: The break-even is Strike price + premium.

Example: An investor is bullish XYZ stock, currently trading at $34 per share. She buys the $35 call for $3. Since each contract equals 100 shares, the total price to enter the trade is $300. This is in contrast to the $3,500 it'd cost to buy 100 shares of the stock. (However, the low price of the contract may tempt her to buy more, putting more money at risk. )

If the stock remains the same, or only moves up a small amount, she loses 100% of her investment. However, if the stock were to tank to $15, she'd only lose $300. This is in contrast to the $1900 she'd lose if she bought 100 shares of the stock. If the stock were to rise, she'd regain her money at $38 per share. If the stock were to rise higher, her potential profit is unlimited.