When I buy call options on the FTSE 100 I don’t buy the index, I buy the call. Too many people confuse the call with the index. Call options track the index. If the FTSE 100 rises the call will rise and if the FTSE 100 declines the call will decline.
Like any other instrument the call has a bid/offer spread, for example if I select the 7250 Call (February 2017) it may be quoted as 20 to buy, 17 to sell.
Many spread betting companies offer options on the FTSE 100, instead of buying a traditional option one can bet on the option using a spread betting platform. The advantage of spread betting is that it’s free from capital gain tax.
I would like to buy the 7250 Call (February 2017), this call will expire on 17th February. The price to buy is 20, however because I spread bet, I will place a bet, say £10. What is my profit/loss potential? The FTSE 100 is trading at 7230 on the day I buy the call.
On 17th February the FTSE 100 has rallied to 7300 and the price of the call is now 40, my profit is £200 (40 – 20 x £10).
Had I bought the FTSE 100 instead of the call I would have made a larger profit. So what is the advantage of buying the call? Buying the call is lower risk, basically when buying a call the potential loss is limited. Had the FTSE 100 gone the other way I would have lost far less than if I was holding the FTSE 100.
Suppose the FTSE 100 was trading at 7150 on the 17th February, my loss on the call would be £200 (0 – 20 x £10). As you can see the maximum loss I can incur when buying a call is the price I pay multiplied by the bet. If I buy at 20 and bet £10 and I am wrong, the maximum loss is £200. That is because when buying a call the lowest it can go is zero, it cannot go lower. That is the advantage of buying the call.
Had I bought the FTSE 100 instead of the call my loss would be far larger, in this example my loss on the FTSE 100 would be £800 (7150 – 7230 x £10).
Options enable traders to profit from a move but with limited risk.
One disadvantage: call options lose value with time
To understand this concept let’s have a look at an example.
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