What is a long call option strategy and how can you use it?

What is a long call option?

A call option gives the holder the right, but not the obligation, to buy an underlying asset at a specific price on or before a specific date. The price is called the strike price, and the date is called the expiration date.

As the call option value is related to the price of the underlying asset, you would buy a call option when you think the underlying asset is going to increase in price. This could be ahead of a specific event, like an earnings release for a company or a central bank meeting.

You would go long on a call option when you are optimistic about the future direction of the underlying security. However, if you are pessimistic about the future direction of the underlying security, you would go long on a put option that increases in value when the underlying asset falls in price.

Long call option vs short call option

The opposite of a long call option is a short call option. If you are short a call option, you have sold the call option. The seller of the call option receives the premium paid, but if the underlying asset increases in price, losses increase – potentially to an unlimited extent. Sellers of the call option have the obligation to sell the underlying asset at the specified exercise price on or before the expiration date. Traders usually only sell a call option if they are already long on the underlying asset, perhaps as a potential hedge if they are concerned that the price of the asset may fall in the short term.

What is a long call option strategy?

When you buy a call option, you are said to be 'long a call'. Being long a call gives you the right, but not the obligation, to buy the underlying asset at the exercise price on or before the expiration date. The amount you pay for the call option is called the premium, and the premium paid is the maximum loss you can take. If the underlying asset increases in price, the call option appreciates in value.

Traders use a long call option strategy to speculate on a higher price of the underlying asset. Traders use a long call option strategy as an alternative to going long a stock or asset outright. However, as the call option is a leveraged instrument, it presents increased risks.

You may want to consider going long a call option that is in the money, as the change in the option's value will more closely correspond to any change in the price of the underlying asset. The option will be more expensive because it has more intrinsic value, but it could be worthwhile.

You have the right to sell the call to close the position at any time, or you can choose to hold the call option until expiry. At expiry, the breakeven level for a long call strategy is the cost of the premium paid, plus the strike price. If the call option is in the money, your account will be credited with the proceeds. If the option is out of the money, meaning below the exercise price, the call option will expire worthless.

Pros and cons of a long call option

Advantages

• Has the potential for high profits, especially if the underlying asset rallies significantly in price
• Provides the holder with leverage, and you can choose the strike price and expiration date to best suit your strategy
• Limited risk because the maximum loss is always limited to the premium paid
• It's commission-free to trade options with us

Disadvantages

• Limited time for the investment to work, as the expiration date determines the duration of the trade. You will lose the premium paid if the price of the underlying asset does not rally sufficiently before the expiration date
• Time decay. Each day that passes, the time value component of the option decreases a little, lowering the price of the call optionImplied volatility estimates the expected price movement of an asset over a period of time and is a key component of option pricing. If the implied volatility is high when you buy the call option, a fall in the implied volatility will lead to a fall in the price of the call option

Example of a long call option strategy

Company XYZ's stock price is currently trading at $40, and you are confident that the share price will rise in the near future.

You could buy a call option with a strike price of $50 and with an expiration date one month later. The cost of the option is $2 per share, so the total premium paid for 100 shares is $200. If this is the case, then $200 would be your maximum loss.

One week after purchase, the stock has rallied strongly and is now trading at $50. The option price will likely have increased to around $10. The total value of the call option would have correspondingly increased to $1,000. If you decide to sell the call option at this point, the profit on the trade will be $800, calculated by the current value of the option ($1,000) minus the initial premium paid ($200).

However, if the share price of company XYZ does not move any higher and, at expiry three weeks later, its share price has fallen to less than $50, then the option will expire worthless because the option is out of the money. There is no intrinsic value.

The breakeven level for the long call option at expiration would be $52. Above $52, the call option has covered the cost of the premium paid. Any price above $52 at expiry will result in a net profit for the call option strategy.

How to trade a long call option strategy

1. Learn more about long call options
2. Open an account or practise with a free demo account
3. Decide whether you prefer to trade options using spread betting or CFDs
4. Select your opportunity: trade options on shares, stock indices, forex or commodities
5. Choose your position size, exercise price and expiration date
6. Open the position and manage your risk

Research your market

UK option traders can choose from a huge number of markets to trade on via our award-winning platform. You can trade options using a spread betting or CFD account with us. Like shares, listed stock options can be traded on registered exchanges – some UK retail traders will do so via a broker. However, this usually requires you to pay a commission, and you may have to deliver, or take delivery of, the underlying asset. We do not ask this. With spread betting or CFDs with us, there is no commission paid on transactions, and all options are cash-settled at expiry.

Remember, trading with spread betting or CFDs comes with added risk attached to leverage. Your position will be opened at a fraction of the value of the total position size – meaning you can gain or lose money much faster than you might expect. When share dealing, you buy and own the shares, so you aren't exposed to this risk. However, you should always keep in mind that past performance won't guarantee future returns.

Learn about the differences between spread betting and CFD trading.

Trading options via spread betting and CFDs

Spread betting has certain advantages. You can choose a certain amount per point movement using spread bets. This gives you more control over your position size and currency exposure. Spread bets are popular with traders because all your profits are tax free, and there is no stamp duty or commission payable.* All spread bets are leveraged, which means you only pay an initial deposit to open the position. However, overall profits are based on the full position size, not your premium size.

You can also trade options using a CFD ('contract for difference') trading account. Like spread bets, CFDs are leveraged products. This means you don't own the underlying asset, but you're betting on its price movement. Your currency exposure and initial margin will vary according to the contract of the asset chosen.

Similar to spread bets, buying options using CFDs limits losses to the initial margin paid. Your wins or losses will depend on the outcome of your prediction. CFDs are popular with traders because you can offset losses on CFDs against profits for capital gains tax purposes.*

* Tax laws are subject to change and depend on individual circumstances. Tax laws may differ in a jurisdiction other than the UK.

How to calculate call option payoffs

A call option payoff depends on the stock price, strike price, the expiration date and the premium paid. The long call option is profitable above the breakeven point, which is calculated by the strike price plus the premium paid. For a call option seller, the breakeven point is the same, but the trade is only profitable if the stock price at expiry is below the breakeven point.

Long call option strategy summed up

• A long call option gives you the right, but not the obligation, to buy an asset at a specific price within a set time frame
• A long call option is profitable when the underlying asset increases in price sufficiently to cover the cost of the premium paid
• Losses on a long call option are limited to the premium paid
• Time decay is one of the key challenges of a long call option strategy, as time decay reduces the value of the option every day

Sources

1. Call Option Payoff – Steady Options