Long Call Option Strategy: A complete guide for beginners

What is Long Call?

Imagine you have a magic ticket that lets you buy a cool gadget at a fixed price anytime in the next month. If the gadget’s price goes up, you can buy it cheaper and sell it for a profit! That’s what a long call option is like. It is an option strategy which gives you the right (but not the obligation) to buy shares of a company at a specific price before a set date.

The investor pays a premium for this right, which represents the maximum risk in the trade. If the stock price rises above the strike price, the value of the call option increases, potentially leading to significant profits.

Why Long Calls are effective?

Long call options are especially popular in bullish markets where investors expect a price increase. With the flexibility to buy stock at a potentially lower price, long calls offer investors leverage. Let’s explore why this strategy is valuable for portfolio management.

Key Benefits

1. Limited Risk, Unlimited Profit Potential: The maximum loss is the premium paid. If the stock doesn’t rise above the strike price, you can let the option expire, losing only the premium. But if the stock price surges, your profit potential is unlimited.
2. Cost-Effective Stock Exposure: The long call lets you control a larger number of shares without having to buy them all outright, making it an affordable alternative to buying stock directly.
3. Flexibility for Hedging Volatility: Investors use long calls not only for potential gains but also as a way to hedge against future price increases, providing a safety net in a volatile market.

When to use a Long Call?

You use a long call when you think the stock price will go up. The farther the price you choose (called the strike price) is from the current price, the cheaper the option. But it also means you’re taking a bigger risk, hoping the price will really soar.

How to get a Long Call?

1. Choose your Option: Options are listed in a menu called the Option Chain. This shows you all the strike prices and expiration dates available.
2. Pay the premium: This is the cost to buy the option. It’s like a ticket price to join the game.
3. Place an Order: You send a buy-to-open (BTO) order to your broker. You can buy it at the current price (market order) or set a price you’re willing to pay (limit order).

What happens next?

1. Payoff Graph

• Risk: The maximum you can lose is what you paid for the option.
• Profit: There’s no limit to how much you can make if the stock price goes up.

For example, if you buy an option to buy a stock at ₹1000 and pay ₹50 for it, the stock needs to go above ₹1050 for you to make a profit.

2. How to exit?

• Sell the Option: Anytime before it expires, you can sell your option to someone else. If the price is higher than what you paid, you make a profit!
• Exercise the Option: If the stock price is above your strike price at expiration, you can use your option to buy the stock at the lower price.
• Let it Expire: If the stock price doesn’t go up, you let the option expire. You only lose the premium you paid.

3. Time and Volatility

• Time Decay: As the expiration date gets closer, the option loses value. It’s like a melting ice cream cone; the closer you get to the end, the less it’s worth.
• Volatility: If the stock is expected to move a lot, the option costs more. High volatility can mean big price jumps.
  Volatility index (VIX) fluctuations can affect option premiums, so factoring in current and expected volatility is critical when selecting a call option.

Adjusting a Long Call

You can convert that into a bull call spread and manage your risk better. Here’s how it works:

• Original Setup: You’re holding a single long call option.
• Adjustment: Sell a call option at a higher strike price.
• Benefit: This reduces your overall cost and lowers the break-even point.
• Drawback: It caps your maximum profit potential.

Example:

• Initial: Bought a ₹1000 call for ₹50.
• Adjustment: Sold a ₹1200 call for ₹20.

Calculations:

• Maximum Loss: Initial premium paid – Premium received from selling the call = ₹50 – ₹20 = ₹30.
• Maximum Profit: Difference in strike prices – Net premium paid = (₹1200 – ₹1000) – ₹30 = ₹200 – ₹30 = ₹170.
• Break-even Point: Strike price of the long call + Net premium paid = ₹1000 + ₹30 = ₹1030.

Rolling a Long Call

Extending the Time Horizon: Sometimes, the stock just needs more time to make its move. If your call option is approaching expiration and the stock price hasn’t increased, rolling the position forward might be a good strategy.

Action: Sell the current call option and buy a new one with a later expiration date.

Example:

• Initial: ₹1000 call expiring in March bought for ₹50.
• Adjustment:
  • Sold the March call before expiry at ₹40 (net loss ₹10).
  • Bought April ₹1000 call for ₹100.

Calculations:

• Net Loss on Original Position: Initial premium paid – Premium received from selling = ₹50 – ₹40 = ₹10.
• Total Cost after Rolling: Net loss on original position + Cost of new call option = ₹10 + ₹100 = ₹110.
• Break-even Point: Strike price of the new call + Total cost = ₹1000 + ₹110 = ₹1110.

So, after rolling:

• Total Cost: ₹110
• Max Loss: ₹110
• Break-even: ₹1110

Hedging a Long Call

If you’re worried about the stock price falling, hedging your long call with a put option can be a smart move. This creates a Long Straddle.

Action: Buy a put option with the same strike price and expiration date as your call option.

Example:

• Initial: ₹1000 call bought for ₹100.
• Adjustment: Bought ₹1000 put for ₹100.

Calculations:

• Total Cost: Cost of call option + Cost of put option = ₹100 + ₹100 = ₹200.
• Break-even Points:
  • Upper Break-even: Strike price + Total cost = ₹1000 + ₹200 = ₹1200.
  • Lower Break-even: Strike price – Total cost = ₹1000 – ₹200 = ₹800.

Bottom Line

In conclusion, a Long Call strategy offers a powerful way to capitalize on potential stock price increases with limited risk. It’s like having a magic ticket that allows you to benefit from the upside while only risking the premium paid.
By incorporating adjustments like bull call spreads or long straddles, investors can enhance their approach, enhancing their risk management strategy.

Whether you’re a beginner or an experienced investor, Long Calls can be a valuable tool in your trading arsenal, providing leverage and flexibility.