Long Call Option Strategy

The long call option strategy is one of the simplest and most widely used strategies in options trading. It involves purchasing a call option with the expectation that the price of the underlying asset will rise significantly above the strike price before the option expires. The long call offers a trader the opportunity to profit from price appreciation in the underlying asset, while limiting risk to the premium paid for the option. This strategy is typically employed when a trader has a bullish outlook on the market or the specific asset and expects a substantial increase in its price.

Introduction

A long call strategy is established by buying a call option, which gives the buyer the right, but not the obligation, to buy the underlying asset at a specified price (strike price) before the option expires. The key features of the long call strategy are:

  1. Buyer: Purchases the call option.

  2. Strike Price: The price at which the underlying asset can be purchased if the option is exercised.

  3. Premium: The cost of purchasing the option.

  4. Expiration Date: The date by which the option must be exercised or it becomes worthless.

The long call is a non-limited profit strategy with limited risk, as the potential gains can be infinite (if the underlying asset rises significantly), while the maximum loss is confined to the premium paid for the option.

What is a Long Call?

A long call is a bullish strategy where an investor buys a call option, betting that the price of the underlying asset will rise. If the price moves above the strike price, the option will become profitable as the trader can buy the underlying asset at the strike price, which is now lower than the current market price. The longer the trader holds the option and the more the underlying price increases, the greater the potential for profit.

Unlike owning the underlying asset, a call option allows the trader to benefit from upward price movements while limiting risk to the initial premium paid for the option. This makes the strategy attractive to traders who expect a substantial increase in asset prices but want to manage their exposure to risk.

Example Scenario

Suppose stock XYZ is trading at $100, and a trader believes that the price of XYZ will rise significantly in the near future. The trader might buy a call option with the following details:

  • Buy 1 XYZ 100 call for a premium of $5.00, with an expiration date in one month.

Here, the trader is purchasing a call option with a strike price of $100 and paying a premium of $5.00. The price of the underlying asset (XYZ) will need to rise above $105.00 ($100 strike price + $5.00 premium) for the trader to make a profit.

Potential Outcomes:

  1. Stock rises above strike price (profitable outcome): If XYZ rises to $120, the trader has the right to buy the stock at $100 and immediately sell it at the market price of $120, making a profit of $20 per share. After deducting the $5 premium, the trader’s net profit is $15 per share.

  2. Stock stays below strike price (unprofitable outcome): If XYZ stays below $100, the call option expires worthless, and the trader loses the entire premium paid, which is $5 per share.

Profit and Loss Analysis

Maximum Profit:

Theoretically, the maximum profit from a long call position is unlimited. As the price of the underlying asset rises, the trader can exercise the call option and profit from the difference between the strike price and the market price. There is no upper limit to how much the asset price can increase, so the potential for profit is effectively unlimited.

Maximum Loss:

The maximum loss in a long call strategy occurs if the price of the underlying asset remains below the strike price at expiration, making the option worthless. The maximum loss is limited to the premium paid for the call option.

  • Max Loss = Premium Paid
    In the example above, the maximum loss is $5 per share, or $500 for a 100-share contract (not including commissions and fees).

Breakeven Point:

The breakeven point is the price at which the trader neither makes a profit nor incurs a loss. For a long call, the breakeven price is calculated by adding the premium paid for the option to the strike price.

  • Breakeven Point = Strike Price + Premium Paid
    For the example above:
    Breakeven Point = $100 (strike price) + $5 (premium) = $105

If the price of the underlying asset rises above $105, the trade becomes profitable. If the price stays below $105, the trader will experience a loss, and the option will expire worthless at expiration.

At-A-Glance Summary

Strategy: Long Call
Alternative Name: Call Option Purchase
Pre-Requisite Strategy Knowledge: Basic Options Trading
Legs of Trade: 1 leg
Sentiment: Bullish
Example:

  • Buy 1 XYZ 100 call for $5.00
    Max Potential Profit (Gain): Unlimited
    Max Potential Risk (Loss): Premium Paid
    Breakeven Point: Strike Price + Premium Paid
    Ideal Outcome: The price of the underlying asset rises significantly above the strike price before expiration
    Early Assignment Risk: Early assignment risk is not a concern for a long call strategy since the holder of the option has the right but not the obligation to exercise. The option is not exercised early unless the holder chooses to do so.

Risks and Risk Mitigation

The primary risk of a long call strategy is that the price of the underlying asset might not rise above the strike price before the option expires. In this case, the trader will lose the premium paid for the option. While the maximum loss is limited to the premium, traders should be aware of the time decay associated with options. As expiration approaches, the value of the option may decrease, even if the price of the underlying asset moves toward the strike price.

To mitigate this risk, traders can:

  • Monitor the price of the underlying asset and set a target for when to sell the option or exercise it.

  • Consider using stop-loss orders to limit losses if the price fails to move in the anticipated direction.

  • Buy longer expiration options if they expect the price to take time to move, although this comes with higher premiums.

A long call strategy is best suited for traders who are bullish on an asset but do not want to commit to purchasing the underlying asset directly. The long call is a versatile strategy that allows for significant upside potential with limited risk, making it an appealing choice for traders who anticipate price movements and want to leverage options to maximize their returns.