Call options provide an opportunity to make big profits if stocks go up with relatively little money at risk – especially compared to the cost of buying shares of stock. Long call option strategies profit from higher stock prices, so the primary goal when using these strategies is to select stocks you think will soon rise in price.
Call Option Function
A call option contract gives the option buyer the right to purchase the underlying stock at a specific price, called the strike price. An option is a limited time contract with an expiration date by which the contract must be exercised to buy the stock, sold or allowed to expire.
A stock will have many different options trading against it with about half a dozen expiration dates and many different strike prices above and below the current stock price. To be "long a call option" means you bought calls on a specific stock. The seller of the calls has a short position in the options.
Long Call Strategy
Buying call options on a stock you think will go up is the basic long call strategy. For example, a stock is at $50 per share, and you think it will go to $60 or higher. You buy call options with a strike price of $50 and a cost of $3.
If the stock moves above $53, your long call option trade is profitable, and you earn $100 for every dollar the stock goes above the $53. (Each option contract is for 100 shares of stock, so an option quoted at $3 costs you $300 and a $1 share price gain is worth $100.) The option value will increase with the stock price, so you can sell your options to lock in the profit.
Long Call Spread
The long call spread strategy allows you to profit from a smaller price gain in the underlying stock. A call spread involves buying call options at one strike price and selling calls at a higher strike price. On the $50 example stock, you buy the $50 strike price call for $3 and sell a $55 strike call for $1; your net cost is $200. With this trade, you reach a profit position when the stock passes $52 per share.
A spread limits your maximum profit to the difference between the strike prices minus the cost of the spread. In this example, you could make a maximum of $300 for the spread if the stock reached $55 or higher.
Considering Potential Losses
With the long call strategies, the most you can lose is the cost to establish the trade, either just buying calls or doing a spread. If the stock price is below the long call strike price when your options expire, you will have a 100 percent loss. If the stock is above the strike price, the long options have intrinsic value, which you can capture by selling the options.
For example, if the stock is at $51 approaching the expiration date, you can sell a $50 strike call option for at least $1, which earns you $100.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.