Long Call
Purchasing calls has remained the most popular strategy
with investors since listed options were first introduced.
Before moving into more complex bullish and bearish
strategies, an investor should thoroughly understand
the fundamentals about buying and holding call options.
Market Opinion?
Bullish to Very Bullish
When to Use?
This strategy appeals to an investor who is generally
more interested in the dollar amount of his initial
investment and the leveraged financial reward that
long calls can offer. The primary motivation of this
investor is to realize financial reward from an
increase in price of the underlying security.
Experience and precision are key to selecting the right
option (expiration and/or strike price) for the most
profitable result. In general, the more out-of-the-money
the call is the more bullish the strategy, as bigger
increases in the underlying stock price are required
for the option to reach the break-even point.
As Stock Substitute
An investor who buys a call instead of purchasing the
underlying stock considers the lower dollar cost of
purchasing a call contract versus an equivalent amount
of stock as a form of insurance. The uncommitted capital
is "insured" against a decline in the price of the call
option's underlying stock, and can be invested elsewhere.
This investor is generally more interested in the number
of shares of stock underlying the call contracts purchased,
than in the specific amount of the initial investment -
one call option contract for each 100 shares he wants to
own. While holding the call option, the investor retains
the right to purchase an equivalent number of underlying
shares at any time at the predetermined strike price until
the contract expires.
Note:
Equity option holders do not enjoy the rights due
stockholders e.g., voting rights, regular cash or special
dividends, etc.
A call holder must exercise the option and take ownership of
the underlying shares to be eligible for these rights.
Benefit
A long call option offers a leveraged alternative to a position
in the stock. As the contract becomes more profitable, increasing
leverage can result in large percentage profits because
purchasing calls generally requires lower up-front capital
commitment than with an outright purchase of the underlying stock.
Long call contracts offer the investor a pre-determined risk.
Risk vs. Reward
Maximum Profit: Unlimited
Maximum Loss: Limited
Net Premium Paid
Upside Profit at Expiration:
Stock Price - Strike Price - Premium Paid
Assuming Stock Price above BEP
Your maximum profit depends only on the potential price increase
of the underlying security; in theory it is unlimited. At
expiration an in-the-money call will generally be worth its
intrinsic value. Though the potential loss is predetermined and
limited in dollar amount, it can be as much as 100% of the premium
initially paid for the call. Whatever your motivation for purchasing
the call, weigh the potential reward against the potential loss of
the entire premium paid.
Break-Even-Point (BEP)?
BEP: Strike Price + Premium Paid
Before expiration, however, if the contract's market price has
sufficient time value remaining, the BEP can occur at a lower
stock price.
Volatility
If Volatility Increases: Positive Effect
If Volatility Decreases: Negative Effect
Any effect of volatility on the option's total premium is on the time
value portion.
Time Decay?
Passage of Time: Negative Effect
The time value portion of an option's premium, which the option holder
has "purchased" by paying for the option, generally decreases, or decays,
with the passage of time. This decrease accelerates as the option
contract approaches expiration.
Alternatives before expiration?
At any given time before expiration, a call option holder can sell the
call in the listed options marketplace to close out the position. This
can be done to either realize a profitable gain in the option's premium,
or to cut a loss.
Alternatives at expiration?
At expiration, most investors holding an in-the-money call option will
elect to sell the option in the marketplace if it has value, before the
end of trading on the option's last trading day. An alternative is to
exercise the call, resulting in the purchase of an equivalent number of
underlying shares at the strike price.
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