The long call option strategy is the most basic option trading strategy whereby the options trader buy call options with the belief that the price of the underlying security will rise significantly beyond the strike price before the option expiration date.
|Long Call Construction|
|Buy 1 ATM Call|
Compared to buying the underlying shares outright, the call option buyer is able to gain leverage since the lower priced calls appreciate in value faster percentagewise for every point rise in the price of the underlying stock
However, call options have a limited lifespan. If the underlying stock price does not move above the strike price before the option expiration date, the call option will expire worthless.
|Long Call Payoff Diagram|
Unlimited Profit Potential
Since they can be no limit as to how high the stock price can be at expiration date, there is no limit to the maximum profit possible when implementing the long call option strategy.
The formula for calculating profit is given below:
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying >= Strike Price of Long Call + Premium Paid
- Profit = Price of Underlying - Strike Price of Long Call - Premium Paid
Risk for the long call options strategy is limited to the price paid for the call option no matter how low the stock price is trading on expiration date.
The formula for calculating maximum loss is given below:
- Max Loss = Premium Paid + Commissions Paid
- Max Loss Occurs When Price of Underlying <= Strike Price of Long Call
The underlier price at which break-even is achieved for the long call position can be calculated using the following formula.
- Breakeven Point = Strike Price of Long Call + Premium Paid
Suppose the stock of XYZ company is trading at $40. A call option contract with a strike price of $40 expiring in a month's time is being priced at $2. You believe that XYZ stock will rise sharply in the coming weeks and so you paid $200 to purchase a single $40 XYZ call option covering 100 shares.
Say you were proven right and the price of XYZ stock rallies to $50 on option expiration date. With underlying stock price at $50, if you were to exercise your call option, you invoke your right to buy 100 shares of XYZ stock at $40 each and can sell them immediately in the open market for $50 a share. This gives you a profit of $10 per share. As each call option contract covers 100 shares, the total amount you will receive from the exercise is $1000. Since you had paid $200 to purchase the call option, your net profit for the entire trade is therefore $800.
However, if you were wrong in your assessement and the stock price had instead dived to $30, your call option will expire worthless and your total loss will be the $200 that you paid to purchase the option.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).
The following strategies are similar to the long call in that they are also bullish strategies that have unlimited profit potential and limited risk.
Going long on out-of-the-money calls maybe cheaper but the call options have higher risk of expiring worthless.
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