Long Call
Purchasing
calls has remained the most popular strategy with investors since listed
options were first introduced.
When
purchasing a long call, you are purchasing the right to purchase the stock. You
don’t have to purchase the stock, but this option gives you the right to do so
at a specific price. If the stock rises above the exercise price by more than
the premium paid, you profit.
Market
Opinion
Bullish
to very Bullish. You are buying the call because you believe the underlying
stock will rise.
P/L
When
to Use
When
you are bullish on a certain stock and believe it will rise in price and want
to capitalize on the profit you can make from that move.
Example
XXXX
is trading at $28.88 on February 20, 2011.
Buy
January 2012 $27.50 strike call for $4.38.
For
$4.38 you bought the right to buy stock at $27.50.
Benefit
A
long call option offers a leveraged alternative to a position in the stock,
costing less than buying the underlying stock.
Risk
vs. Reward
The
risk is limited, while the profit potential is unlimited.
Net
Upside
Unlimited
upside.
Net
Downside
Limited
to the price you pay for the call.
Break
Even Point
Strike
price plus premium paid.
Effect
Of Volatility
If
Volatility Increases: Positive Effect
If
Volatility Decreases: Negative Effect
Effect
Of Time Decay
Negative
effect. The time value part of the call’s premium decays over time,
accelerating as the call comes closer to expiration.
Alternatives
Before Expiration
To
avoid time decay, sell the long option before the last month of the contract.
If
the stock falls under your stop loss, close out by selling the calls.
Alternatives
At Expiration
Sell
an in-the-money call. Or exercise the call and buy the stock at the strike
price.
