Published August 29, 2011
A long call gives you the right to buy the underlying stock at strike price A.
Calls may be used as an alternative to buying stock outright. You can profit if the stock rises, without taking on all of the downside risk that would result from owning the stock. It is also possible to gain leverage over a greater number of shares than you could afford to buy outright because calls are always less expensive than the stock itself.
But be careful, especially with short-term out-of-the-money calls. If you buy too many option contracts, you are actually increasing your risk. Options may expire worthless and you can lose your entire investment, whereas if you own the stock it will usually still be worth something. (Except for certain banking stocks that shall remain nameless.)
THE SET UP
• Buy a call, strike price A
• Generally, the stock price will be at or above strike A
WHO SHOULD RUN IT
• Veterans and higher
WHEN TO RUN IT
You’re bullish as a matador.
BREAK-EVEN AT EXPIRATION
Strike A plus the cost of the call.
THE SWEET SPOT
The stock goes through the roof.
MAXIMUM POTENTIAL PROFIT
There’s a theoretically unlimited profit potential, if the stock goes to infinity. (Please note: We’ve never seen a stock go to infinity. Sorry.)
MAXIMUM POTENTIAL LOSS
Risk is limited to the premium paid for the call option.
AS TIME GOES BY
For this strategy, time decay is the enemy. It will negatively affect the value of the option you bought.
After the strategy is established, you want implied volatility to increase. It will increase the value of the option you bought, and also reflects an increased possibility of a price swing without regard for direction (but you’ll hope the direction is up).
Options involve risk and are not suitable for all investors. Click here to review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time.
Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult your tax adviser.
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