Options trading can be an exciting form of trading, and there can be opportunity to make big profits while also reducing the risks. With so many options strategies to choose from, it can be challenging for a beginner to decide which approach will work best in which situation.
The long call option strategy is ideal for those looking out to make profits from bullish movements. However, what precisely does this entail and when should you use it?
In short, a long call option strategy:
- is the most basic options trading strategy.
- requires the trader to buy options.
- is betting that the price of the security underlying the option will rise significantly above the strike price before the expiration date.
Before we delve into the details of the long call option strategy, we’d first like to explain what options are in general.
What Are Options and What Type of Options Are There?
Options may sound complicated but are simple concepts. At their most basic, an option is just a contract with a set expiration date. This contract provides the bearer the right, but not the obligation, to be able to purchase or sell a particular asset at a specified price within an established timeframe.
The price at which the underlying asset will be sold or purchased is the strike price. However, you should note that it is not essential for the options bearer to buy or sell anything because options are not an obligation but a right. In other words, the owner of an option has, well, the option to buy or sell the underlying security, depending on the type of option. The cost of the option itself is called the premium.
Options are of two main types: call options and put options. A call option gives the bearer the right to buy an asset at a specified price within a certain period. A put option, on the other hand, allows her the ability to sell his stock at the strike price within the timeframe established.
The Long Call Option Strategy
The long call option strategy entails buying call options on an underlying stock for which you perceive bullish trends. Note that you can also buy stocks directly but this involves additional capital requirements. Furthermore, this also includes the risk that the price of the stock might never rise or could instead fall. If you purchase a call option, on the other hand, you can profit from price rises.
When using a long call option strategy and the price does not rise but instead falls, you will never need to exercise the option and it will only expire. In other words, the maximum loss you can incur is limited to the premium you paid for the options contract.
The question remains, how do you select the right long call? As you gain more experience as an options trader, you will understand the dynamics of this space much better. In general, you should consider the strike price and the expiration date of the long call before you purchase it. These factors, along with the entry price of the trade, will determine your profits to a great extent.
Furthermore, you should also note that the value of the call options contracts decreases as the expiration date approaches due to what is known as time decay.
Executing the Long Call Option Strategy: The Long Call Spread Strategy
The long call spread strategy is another important trading strategy to consider. In this case, you intend to make profits when the price increases are likely to be small. The long call spread strategy entails undertaking two simultaneous trades.
You would buy call options anticipating the price rise while also selling another call at a higher strike price. You end up using the premium of the sold calls to combat the expenditures in buying the call at the lower strike price.
By doing this your profit is also capped. This is an inevitable shortcoming that accompanies the many benefits of this strategy. The maximum profit is limited to the difference of the strike prices less the cost of the spread itself.
You will immediately realize that the long call spread strategy is an excellent alternative to a simple long call. Unlike the long call though, there is a constraint on the profits. However, you will avoid having to deposit large premium upfront with the second cheaper call financing a bit of that portion of the trade. There is also a reduced risk to this type of “spread” trade, and as long as the trade does not go against you significantly you may keep the premium for the trade.
Another factor to consider is time decay, the fall in an option’s value over time, does not impact a long call spread strategy as much as it does a long call.
Choosing The Right Long Call Strategy
There are several options strategies you can select from. Let’s say you are positive of an upcoming bullish trend. Choosing a call option will offer some benefits, weighing in the risks of course. You can choose either the a long call or a long call spread strategy.
There are several factors to consider in this regard and that will assist you in making the right decision. If you anticipate a very sharp price rise, it can make more sense to opt for a long call. This way, you have the opportunity to make maximum profit because there is no upper profit limit to your trade.
What if you’re positive about a price spike but are also sure that the price rise will only be limited or that it is likely to face some resistance later? You might consider the long call spread strategy in that case. Doing so will help you establish the approach with a smaller cost than only a long call while still being able to profit. Of course, it’s a trade-off and you might lose potential profits if the price continues to rise. However, you trade that for the lower entry point into the setup. Spreads also tend to be less risky in general.
Check out this great article about the call spread and the right way to use this strategy for the maximal profits.
Pros and Cons of Long Call Options
There are pros and cons to a long call option strategy. Let’s start with some of the advantages first.
- The main advantage of the long call option strategy is the profit potential and the ability to limit your losses to the premium associated with the options trade. On the other hand, if you purchase the stock outright, the price could fall right down to zero, at least theoretically, with nothing holding you secure.
- With a call option, you do not have to shell out a large amount of money to purchase the underlying assets while still holding some form of control over them.
- Options are also highly flexible since there are several factors to consider including the expiration time and the strike price, for example. There are several combinations to choose from.
Some of the critical disadvantages associated with long call options are as follows;
- A significant disadvantage of the long call is the associated upfront payment that must be made to purchase the call. You can use a long call spread to minimize the setup cost if you so wish. However, it will also affect the potential profits.
- A negative impact can occur as the options’ expiration date comes closer. Their value falls and the window to make profits narrows.
A long call can prove to be a very profitable strategy if the bullish trend continues to soar higher. In this case profits are virtually unlimited and depend only on how high the stock price goes. However, in reality, price rises might often be limited in their extent which calls for a better call strategy that presents you with lower costs. However, this is where the long call spread strategy excels, although with the disadvantage that it caps your potential profit levels.
Ultimately, you will need to practice a lot before you can identify patterns and make better quality decisions in order to execute the long call option strategy. Options trading is both an art and a science and there are limitless opportunities for those who have mastered their craft. It certainly takes time but you can eventually make your mark.
We highly recommend that you go through our fantastic resource article on options trading which will describe essential strategies and tips you should be aware of straight from options trading experts who have years of experience in this field.