Long Call Option

Submitted by admin on Thu, 11/25/2021 - 20:56


Although a long call strategy seldom appreciates in lockstep with the stock, pricing models may frequently provide a realistic approximation of how a $1 stock price movement would effect the call's value, provided all other variables stay constant.
Furthermore, if the projection is accurate, the percentage profits compared to the premium might be large.


The call buyer who intends to resell the option for a profit is searching for appropriate occasions to close the position out early, which are often a rally and/or a dramatic spike in volatility.
Others 'play it by ear,' setting price objectives or re-evaluation dates.
In any case, time is crucial for this technique since the entire value must be achieved before the option expires.
It doesn't matter if you were correct about an impending rally if it happens after the expiration date.


A cautious investor is prepared to re-evaluate if the gains do not materialize before the expiration date.
One option is to wait and see whether the stock rises in value before the expiration date.
If it does, the approach may, after all, make a significant profit.

 


EXAMPLE


1 QQQ 200 call long.


GAIN MAXIMUM


Unlimited


LOSS MAXIMUM


Payment of a premium


On the other hand, if a speedy reversal appears doubtful, selling the call while it still has some time value may be a good idea.
An investor who makes a timely choice may be able to regain some or all of his or her money.

Outlook


A call buyer is clearly positive in the short term, expecting the underlying stock to rise throughout the option's duration.


The long-term view of an investor might be highly positive, slightly bullish, or even neutral.
If the long-term prognosis is overwhelmingly gloomy, a different technique may be more suited.

Summary


Buying a call option is part of this technique.
Buying a call allows investors to share in the predicted appreciation of the underlying stock throughout the option's period.
If everything goes according to plan, the investor will be able to profitably sell the call before it expires.

Motivation


The investor buys calls to profit from price rise in the underlying stock without the risk and up-front cash outlay that comes with owning the asset entirely.
The buyer will also be able to obtain bigger percentage profits due to the lower initial investment (i.e., greater leverage).

Variations


This debate is aimed at the long call investor, who buys a call option with the intention of reselling it at a profit later.


See cash-backed call, a version of the long call strategy, where obtaining the underlying shares is a primary goal.
In such situation, the investor purchases the call while also setting aside funds to purchase the shares.
The call then functions as a 'rain check,' providing a limited-time guarantee on the stock price for investors who want to buy the company but are hesitant to do so right immediately.
This strategy is especially useful if a significant price change is foreseen in the near future.

Maximum Loss


If the investor still holds the call at expiration and the stock is below the strike price, the maximum loss is restricted.
The call option would expire worthless, and the loss would be equal to the price paid for it.

Maximum Gain


The potential for profit is theoretically limitless.
The best-case scenario is for the stock price to increase indefinitely.
In that instance, the investor might either sell the option for a nearly unlimited profit or exercise it and buy shares at the strike price, then sell it for 'infinity.'

Profit/Loss


The profit potential is limitless, but the loss risk is restricted to the premium paid for the call.


Although a call option is unlikely to appreciate a full $1 for every dollar that the stock increases over the majority of the option's life, there is no limit to how high either may go in principle.
The possible percentage profits might be significant given the small size of the investment (i.e., premium).
The catch is that all gains must be realized by the call's expiration date.
In general, the long call strategy benefits from an earlier and stronger growth in the stock's value.


When all other factors are equal, an option's time value premium tends to erode with each passing day, and the pace of time value erosion tends to increase.
That implies the long call holder may not be able to profitably resell the call until at least one important price component moves in his or her favour.
The most visible is a rise in the price of the underlying stock.
A spike in implied volatility might also benefit by increasing the time value of the call.


An option holder cannot lose more than the option's initial purchase price.

Breakeven


If the stock price is equal to the strike price plus the initial cost of the call option at expiration, the strategy breaks even.
Any stock price higher than that results in a net profit.
To put it another way:


Strike + premium Equals breakeven.

Volatility


All other things being equal, a rise in implied volatility would be beneficial to this approach.
Volatility tends to increase the value of any long option strategy since it signals a higher mathematical chance that the stock will move sufficiently before expiry day to provide the option intrinsic value (or add to its present intrinsic value).


Similarly, regardless of the general stock price trend, a decrease in volatility tends to reduce the value of the long call strategy.

Time Passes


All other factors being equal, the passage of time has a negative influence on this strategy, as it does with most long option strategies.
The statistical probability of generating further gains in intrinsic value decrease as the time left until expiry decreases.
Furthermore, compared to an outright long stock position, the cost-to-carry savings afforded by a long call strategy diminishes with time.


When temporal value vanishes, only intrinsic value remains.
That is the difference between the stock price and the strike price for in-the-money options.
Intrinsic value is 0 for both at-the-money and out-of-the-money options.

Assignment Danger


None.
The investor has the upper hand.

Risk of Expiration


Slight.
If the option expires in the money, your brokerage company may exercise it for you.
Because this investor has not set aside the funds to purchase the shares, an unexpected exercise may be a big hardship, necessitating immediate action to get the funds for settlement.


Every investor with a long option position that is approaching expiration should double-check all associated processes with their brokerage firm, including automatic exercise minimums, exercise notice deadlines, and so on.

Comments


All option investors have a motive to keep an eye on the underlying stock and dividends.
This is true for long call holders as well, whether or not they intend to buy the stock.


The amount of the dividend is taken from the value of the underlying shares on an ex-dividend date.
This exerts downward pressure on the value of the call option.
Dividend dates are still a factor in determining when it could be best to close out the call position, despite the fact that the effect is predictable and normally gets factored in more gradually.


If a dividend has been declared and the holder of an in-the-money call decides to exercise the option, it may be best to execute the call before the ex-dividend date to collect the dividend payout.

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