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Long Call
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| Risk: |
Limited |
| Reward: |
Unlimited |
| The Trade: |
Buy and out of the money call option |
ABC Stock trading at £5.00
Buy 1 Sep £5.50 call (see pay-off diagram below)
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| When to use: |
Very bullish on a stock's price. The more bullish the higher the strike should be. No other position gives you as much leveraged advantage with limited downside risk. |
| Volatility expectation: |
Volatility bullish. Volatility increases greatly help the position, volatility decreases can be a disaster if the option was bought when volatility was high. |
| Profit: |
Unlimited in a rising market. |
| Loss: |
Limited to the initial premium, maximum loss if market expires at or below the option strike. |
| Breakeven: |
Reached when the underlying rises above the strike price, by the same amount as the premium paid to establish the position. |
| Time decay: |
This position is a wasting asset. As time passes, value of position erodes toward expiration value. If volatility increases, erosion slows, if volatility decreases, erosion speeds up. |
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Trading ideas and tactics:
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- Be very cautious about buying options (puts or calls) in high volatility environments. Often you will be right on your direction but lose or make a tiny profit because of contracting volatility
- If you do buy calls when volatility is high then try and take profits/losses quickly before a reduction in volatility starts to take effect on premiums. Almost like a smash & grab raid, in quickly and out quickly (say within a week)
- Your timing must be excellent when buying calls. You almost want to see the market move in your favour that day
- Don't look to buy options with less than 30 days left to expiry - Time erosion is at its highest. Better to buy options with 30 - 60 days till expiry. Yes, they're more expensive but better chance of making a profit
- Instead of buying one option and if wrong, letting it expire worthless, consider buying two options with the same monetary risk. If the two options reduce in value by 50% then dump the position
- Try and sell a portion of your position if the option doubles, then consider selling the other part of the position if the option trades back to the original purchase price
- Always assume that your timing will be off when buying calls and take this into account
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