The long call option strategy is the most basic
option trading strategy whereby the options traders 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
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Buy 1 ATM Call
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Leverage
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 percentage wise 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.
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Long Call Payoff Diagram
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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
Limited Risk
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
Breakeven Point(s)
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
Example
Suppose the stock of XYZ Company is trading at Rs40.
A call option contract with a strike price of Rs40 expiring in a month's time
is being priced at Rs2. You believe that XYZ stock will rise sharply in the
coming weeks and so you paid Rs200 to purchase a single Rs40 XYZ call option
covering 100 shares.
Say you were proven right and the price of XYZ
stock rallies to Rs50 on option expiration date. With underlying stock price at
Rs50, if you were to exercise your call option, you invoke your right to buy
100 shares of XYZ stock at Rs40 each and can sell them immediately in the open
market for Rs50 a share. This gives you a profit of Rs10 per share. As each
call option contract covers 100 shares, the total amount you will receive from
the exercise is Rs1000. Since you had paid Rs200 to purchase the call option,
your net profit for the entire trade is therefore Rs800.
However, if you were wrong in your assessment
and the stock price had instead dived to Rs30, your call option will expire
worthless and your total loss will be the Rs200 that you paid to purchase the
option.
Disclosure/Disclaimer and FAQ
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