Long Call

The Long Call Setup

Assume you are interested in a company named TechGiant which is currently trading at $150 a share. Due to some product launches, you think there is scope for significant growth in the stock price in the next couple of months, so you buy a call option with a strike price of $160 which expires in three months at a cost of $5 per option.

Who Should Consider It

If you are a long call holder then this strategy is perfect for investors that are more aggressive (bullish) and expect an increase in price in the underlying asset. It is also good for people that have moderate risk tolerance since the worse thing that can happen is that you lose the option premium.

Strategy Explained

In other words, when you buy a call option, you buy the right to get an asset for a set amount of money (strike price) before a specific date. This tactic allows traders to invest in a stock without having to pay the price to buy it outright.

Breakeven Process

In the long call approach, profit starts to accrue once the breakeven point is achieved, which is determined by how much premium has been added to the strike price. In this case, the premium given example is $5 and breakeven is at $160. The strike price set at $165 means that the stock value must go up to at least $165 by expiration, otherwise there is no profit to be attained.

Sweet Spot

The sweet spot in this case assistance occurs from the moment the assets stock price exceeds the breakeven amount and keeps going higher. Consequently, the maximum recorded stock price achieved after expiration dictates the level of profitability, which can reach exponentially higher amounts.

Max Profit Potential

The level of maximum profit is limitless, considering the trade is only capped by the maximum stock price achieved, which in relation to the other stock prices dictates the potential profit. The rise in the stock price has no proximate ceiling above it, making the profit do the same.

Max Loss

The loss suffers is limited to the premium outlined in the call option. With TechGiant’s stock price forecasted to not go beyond $160, there will be expiration of premium share value, resulting in an option that is glaringly worthless. The investment made translates to a loss of $5 per every single share premium, nothing beyond that.

Risks

The main risk is that the stock price does not grow as expected, resulting in a Pareto loss. In contrast to holding the stock, where keeping it for longer periods could still earn you some dividends or a price appreciation, an expired option does not give any return.

Obsolescence of Value

An example of time decay is when the value of the long call option drops as the time of expiration approaches. The core phenomenon used in estimation, which is time decay, describes the depreciation in value of long call option when the expiration approaches. From the point just before the expiration, the rate at which the options value diminishes increases sharply, especially when the underlying asset is trading at a price lower than the strike price.

ITM Option Premiums

Implied volatility is the expected magnitude of changes in price of a security within a specified time frame. Usually, options with higher implied volatility sell at a higher premium. During the lifecycle of a call option, increased volatility is good for long call strategy, as it will significantly increase the probability of realizing a stock price above the strike price towards the expiration of the option, thus increasing the value of the option.

Conclusion

Long calls have a high payoff but are risky in nature, as they depend on the price of an asset moving higher as well as increased market volatility. Traders can lock in their maximum potential payoff with a predetermined investment. However, due to the time sensitive essence of options, there is also the chance that if the investors’ projection regarding the stock does not come to fruition, they could end up losing all their investment. Thus, traders need to evaluate market conditions and their own risk appetite before implementing a long call option strategy.