The long call option strategy is perhaps the most popular options strategy and the first strategy any potential options trader should learn. In its simplest form it comprises of buying call options with the belief that the price of the underlying security will rise beyond the strike price before the option expiration date.
Since there’s no limit to how high the stock price can rise to at expiration, there’s no limit to the maximum profit that’s possible when trading the long call options strategy.
To calculate the profit margin for your trade use the formula below:
- Profit Achieved When Price of Underlying = (Strike Price of Long Call + Premium Paid).
- Profit = Price of Underlying – Strike Price of Long Call – Premium Paid
The risk involved trading long call options is limited to the price paid for the call option no matter how low the stock price is trading on the expiration date.
To calculate the maximum loss for your trade use the formula below:
- Max Loss = Premium Paid + Commissions Paid
- Max Loss Occurs When Price of the Underlying Asset = Strike Price of Long Call
The breakeven point is a critical moment in any options trade; you should work out the breakeven point of every trade you intend to make before you make it. To work out the breakeven point, use the formula below.
Breakeven Point = Strike Price of Long Call + Premium Paid
Let’s say Amazon (AMZN) is trading at $40. A call option contract with a strike price of $40 expiring in one month’s time is priced at $2. You believe that AMZN stock will continue to rise in the coming weeks, so you buy a single call option in AMZN for $40. A single call option covers 100 shares, so this purchase costs you $200 ($2 x 100 = $200).
After a few weeks the price of AMZN has risen to $50. With the underlying stock price at $50, you could invoke your right to buy 100 shares of AMZN stock at $40 each and sell them immediately in the open market for $50 a share. This gives you a profit of $10 per share. Since each call option contract covers 100 shares, the total amount you will receive from the trade is $1000. Since you paid $200 to purchase the call option in the first place, your net profit for the entire trade is $800.
However, what if you were wrong, what if the price of AMZN dropped to $30. In this scenario your call option will be worthless, remember you’re under no obligation to buy the shares, so your total loss will be limited to the $200 that you paid to purchase the option.
For the sake of simplicity the above example doesn’t take into account any trading commissions. Every time you buy or sell an option, your broker will charge you a small commission. The amount you pay will depend on your broker but typically it’s around $10 or $20 per trade.
This is fine if you’re only trading once or twice a week, but what if you’re trading once or twice a day, these commission prices can add up to a significant amount. Fortunately for active traders there are specialty brokers that charge significantly lower commissions but expect you to trade on volume to make up for it.
A good example of a broker like this would be OptionsHouse who charge as little as $0.15 per contract, but only if you trade more than 10 contracts at a time.
Hopefully we’ve removed some of the mystery surrounding options trading. If you’re still not sure sign up for a virtual account and carry out a few test trades. The long call strategy is the simplest and most common options strategy, so start with this and once you’ve mastered it you can confidently move on to some more complex strategies later on.