What is a Call On A Call?

A call on a call is a special kind of option. It lets you buy another option, instead of an underlying asset directly. The option you can buy with a call on a call is a regular call option. A regular call option lets you buy an underlying asset, like a stock, at a set price by a set date.

Why Would Someone Buy A Call On A Call?

You might want to buy a call on a call if you think you might need to buy a call option on a stock in the future. But you aren’t sure yet if you will actually need that call option.

Buying the call on a call gives you more time to decide. You don’t have to buy the call option on the stock right away. The call on a call lets you wait and see what happens with the stock.

If the stock goes up by a lot, you’ll probably want to buy the call option on it. The call on a call you bought earlier will let you do that. You can use it to buy the call option on the stock at the price that was set when you bought the call on a call.

If the stock doesn’t go up, you might not want to buy the call option on it anymore. In that case, you can just let your call on a call expire. You’ll lose the money you paid for the call on a call. But you won’t lose as much as you would have if you had bought the call option on the stock directly.

How Calls On Calls Work

Calls on calls have two strike prices and two expiration dates. These are called the compound strike price and compound expiration date, and the underlying strike price and underlying expiration date.

The compound strike price and compound expiration date are about the call on a call contract itself. The compound strike price is the price you have to pay to buy the underlying call option. The compound expiration date is the date by which you have to decide if you want to buy the underlying call option.

The underlying strike price and underlying expiration date are about the underlying call option you can buy. The underlying strike price is the price you’d have to pay to buy the underlying stock if you use the option. The underlying expiration date is the date by which you’d have to use the underlying call option.

Here’s an example of how it works:

You buy a call on a call
Its compound strike price is $5 and its compound expiration date is January 1
The underlying call option has a strike price of $100 and an expiration date of February 1
That means before January 1, you have the right to pay $5 to buy a call option
That call option would let you buy the underlying stock for $100 before February 1

Key Things To Know About Calls On Calls

There are a few important things to understand about how calls on calls work compared to regular call options.

Higher Potential Gains And Losses

Calls on calls give you the potential to make a lot more money than a regular call option. That’s because you’re buying the right to buy a call option. If the underlying stock goes way up, the call option will become very valuable. Your right to buy that call option could be worth a lot.

But calls on calls are also riskier than regular call options. You could lose money on both the initial call on a call and the underlying call option. With a regular call option, you can only lose what you paid for that one option.

More Complicated To Understand

Calls on calls are more complex than regular call options. They have more moving parts. There are the two strike prices and two expiration dates to keep track of. It can be confusing to understand how changes in the underlying stock will affect the value of the call on a call.

You really need to understand options well before you trade calls on calls. If you’re new to options, it’s better to start with regular call options. You can move on to calls on calls once you’ve got more experience.

Not As Widely Available

Not all options trading platforms offer calls on calls. You might have to look around to find a broker that will let you trade them. And the selection of calls on calls available to trade is usually limited.

Regular call options on stocks are much more common. Most brokers offer them and you can usually find one for any widely traded stock.

Real World Examples

Here are a couple examples of how a trader might use calls on calls in the real world.

Speculating On A Specific News Event

Let’s say a big tech company is about to release a new product. The trader thinks if the product is a hit, the company’s stock will go way up. But if it’s a flop, the stock might not move much or could even go down.

The trader could buy a call on a call that lets them buy a regular call option on the company’s stock. They might pick a compound expiration date that’s after the product release. That way, they can wait and see how the market reacts to the news.

If the product is a hit and the stock soars, they can use the call on a call to buy the now very valuable regular call option. If the product flops and the stock doesn’t move, they can just let the call on a call expire.

Buying More Time To Analyze A Trade

A trader might also use a call on a call to buy themselves more time to analyze a potential options trade.

Say they’re watching a stock that’s been going up, but they’re not sure the rally will continue. They could buy a call on a call with a compound expiration date a couple weeks in the future.

That gives them time to see if the rally continues and decide if they want to buy the regular call option. In the meantime, they’ve limited their risk to just the cost of the call on a call.

Risks And Drawbacks

While calls on calls have some attractive features, they’re not without risks and downsides.

Potential For Big Losses

As mentioned earlier, you can lose money on both the call on a call and the underlying call option. Your losses can add up quickly if the underlying stock moves against you.

High Costs

Calls on calls are usually pretty expensive compared to regular call options. You’re paying for the extra flexibility they offer. Those costs eat into your potential profits.

Low Liquidity

Because calls on calls are less common than regular options, they can be harder to buy and sell. There might not always be another trader willing to take the other side of your trade.

That low liquidity can make it difficult to enter or exit a position at a good price. And if you can’t find a buyer, you might get stuck holding a call on a call you don’t want anymore.