Long call options give the buyer the right, but no obligation, to purchase shares of the underlying asset at the strike price on or before expiration. Because options are levered, each contract is equivalent to holding 100 shares of stock. An advantage of using a long call option is that less capital is required to own one contract compared to the cost of owning 100 shares of stock, and downside risk is limited to the option contract’s cost.
A long call is purchased when the buyer believes the price of the underlying asset will rise by at least the cost of the premium on or before the expiration date. Further out-of-the-money strike prices will be less expensive but have a lower probability of success. The further out-of-the-money the strike price, the more bullish the sentiment for the outlook of the underlying asset.
A long call trade is initiated when a buyer purchases a call option contract. Calls are listed in an option chain and provide relevant information regarding each option for every strike price and expiration available, including the bid-ask price. The cost to enter the trade is called the premium. Market participants consider multiple factors to assess the value of an option’s premium, including the strike price relative to the stock price, time until expiration, and volatility.
The payoff diagram for a long call is straightforward. The profit potential is unlimited, and the maximum risk is limited to the cost of the option. Entering a long call requires paying a debit and the amount paid is the most an investor can lose on the trade. To break even on the trade, the stock price must exceed the strike price at expiration by the cost of the long call option.
For example, if a long call option with a strike price of $100 is purchased for $5.00, the maximum loss is defined at -$500 and the profit potential is unlimited if the stock continues to rise. However, the underlying stock must exceed $105 to realize a profit.
To enter a long call position, a buy-to-open (BTO) order is sent to the broker. The order is either filled at the asking price (market order) or at a specific price an investor is willing to pay (limit order). Once a call option is purchased, cash is debited from the trading account.
There are multiple ways to exit a long call position. Anytime before expiration, a sell-to-close (STC) order can be entered, and the contract will be sold at the market or limit price. The premium collected will be credited to the account.
If the contract is sold for more premium than originally paid, a profit is realized. If the contract is sold for less premium than originally paid, a loss is realized. If the long call option is in-the-money at expiration, the holder of the contract can choose to exercise the option and will receive 100 shares of stock per contract at the strike price.
Time remaining until expiration and implied volatility make up an option’s extrinsic value and impact the price of the premium. Options contracts with more time until expiration will have higher prices because there is more time for the underlying asset to experience price movement. As time until expiration decreases, the price of the option goes down. Time decay, or Theta, works against options buyers.
Implied volatility reflects the possibility of future price movements. Higher implied volatility results in a higher price of the option because there is an expectation the price will move more in the future. As implied volatility decreases, the price of the option goes down. Options buyers want to buy options when the expectation is implied volatility will be higher on or before expiration.
Long call options positions can be managed during a trade. Long call positions where the underlying security’s price moves away from the long call strike price can be adjusted to extend the time duration of the trade or converted to a risk-defined debit position to minimize loss. The ability to roll options positions into the future allows the trade more time to become profitable, but will come at a cost because more time equates to higher options prices.
If the stock price falls below the long call strike price, a call option can be sold at a higher strike price to decrease the trade’s maximum loss. For example, if a $100 call option is owned, a $105 call option can be sold. This will lower the overall cost to the original position and lower the break-even price. However, doing so will limit the maximum gain on the position.
If an investor wants to extend the trade, the long call option can be rolled out to future expiration dates. Rolling out the option requires selling-to-close (STC) the currently held position and buying-to-open (BTO) an option with the same strike price at a future date. Doing so will likely result in paying a debit and will add cost to the original position.
To hedge a long call, an investor may purchase a put with the same strike price and expiration date, thereby creating a long straddle. If the underlying stock price falls below the strike price, the put will experience a gain in value and help offset the loss in value of the long call. However, this adds cost to the original trade and will extend the break-even price.
Another strategy to hedge a long call is to sell a call above the original strike price to create a call debit spread. Adding the short call collects a credit and reduces the overall cost of the trade. However, this will limit the upside potential because the seller is obligated to sell shares at the higher strike price.
A synthetic long call combines long stock with a long put option at the entry price of the original long stock position. This creates a synthetic long call because the payoff diagram is similar to a single long call option. The maximum downside risk is limited to the long put option’s strike price, and the upside potential is unlimited if the stock continues to rise.