Options Strategy: Long Call

Buying call options has been a popular strategy for investors since listed options were first introduced. Investors should thoroughly understand the basic concepts of buying and holding call options before moving on to more complex bull and bear strategies.

Market view?

Bullish to very bullish.

When to use?

This strategy is attractive to an investor who is generally concerned with the amount of his initial investment and the skewed financial return from long call options. The investor’s primary motivation is to obtain financial returns from an increase in the price of the underlying security. Experience and accuracy are key to selecting the right options (determined by expiration date and, or strike price) to achieve maximum profit. Generally speaking, the greater the number of call options that go out-of-the-money, the more bullish the strategy becomes. This is because the price of the underlying stock needs to increase more for the option to reach the break-even point.

As a stock alternative

An investor who buys call options instead of the underlying stock sees the smaller amount of money required to purchase a call contract as a form of insurance compared to the corresponding amount of stock. The uninvested money is “protected” from a decline in the price of the call’s underlying stock and can be invested elsewhere. This type of investor is usually more interested in the number of underlying shares controlled by the option contract purchased than in the specific amount of the initial investment. One call contract is equivalent to one hundred shares of stock that the investor wants to own. During the period of holding the call option, and at any time before the contract expires, the investor has the right to purchase a certain number of underlying shares at a predetermined strike price.

Note: Common stock option holders do not receive the rights of stockholders. These rights include voting rights, periodic cash or special dividends, etc. Call option holders must exercise the option and own the underlying stock to qualify for these rights.

benefit?

A call option contract is a substitute for the leverage of a stock position. When the contract is more profitable, the added leverage can lead to a greater proportion of the profit. This is because buying a call option generally requires a smaller initial capital investment than the funds used to directly purchase the underlying stock. The risk that a long call option contract brings to the investor is predetermined.

Risks and benefits?

Maximum profit: Unlimited

Maximum loss: Limited (net value of premium paid.)

Cap profit at expiration: Stock price – Strike price – Premium paid (assuming the stock price is above the break-even point.)

Your maximum profit depends only on the potential price increase of the underlying security. In theory, this profit is unlimited. At expiration, the value of an in-the-money call option usually has intrinsic value. Although the potential loss is predetermined and limited in absolute amount, it could be 100% of the premium originally paid for the call option. Whatever your motivation for buying a call option, weigh the potential gain against the potential loss of the entire premium.

Break-even point?

Break-even point: Strike price + premium paid

However, before the expiration date, if the market price of the contract has sufficient time value, the break-even point will be lower than this price.

Volatility?

If volatility increases: Positive effects

If volatility decreases: Negative effects

The impact of volatility on the total premium of an option is in the time value portion.

Time weakening?

The Passage of Time: Negative Effects

The time value portion of the option premium that the option holder “purchases” when buying the option generally decreases, or weakens, over time. This decrease accelerates as the option contract approaches expiration.

What are the other options before the expiration date?

At any time before the expiration date, the holder of a call option can sell the call option in the listed options market to close the position. This can earn a profit on the option premium or reduce losses.

What are the other options at the expiry date?

At expiration, most investors holding premium call options will choose to sell the option in the market before the end of trading on the last trading day of the option. Another option is to exercise the option and buy a considerable amount of the underlying stock at the exercise price.