Learning to trade options can be an excellent way to accelerate the profit of your investment portfolio. However, options can be a risky strategy if performed the wrong way or at the wrong time. If you are new to investing, taking the time to learn options strategies, and deciding which one is suitable for you, can go a long way to building successful portfolio. Recently, we wrote about two more advanced options strategies; The Naked Put and Covered Call. However, some option strategies are more suited for beginners and even have a stronger profit potential and lesser risk. One of these strategies that fits this bill is called “The Long Call Option.”
A long call is an option strategy where an investor is very bullish on a stock, so they purchase a call option believing that the stock price will exceed the strike price before the expiration date.
As we mentioned, this is a great option strategy for beginners because not only is it one of the most straight-forward options, but it also has unlimited profit potential while the risk is limited to the premium paid for the options contract.
The profit received from a long call is in the form of capital appreciation of the stock above strike price. This profit increases by $100 for every $1 dollar the stock price rises above the strike price.
Theoretically, if the price of the stock price exceeds the strike price at expiration and continues to climb, you could ride the profits as long as you can since you have no obligation to sell the contract.
If the stock price does not exceed the strike price at expiration, the option expires worthless. However, the only loss is the premium you paid for the contract as there is no further downside.
This is why the easy-to-understand nature and profit potential of the long call option is such an attractive option strategy for beginners.
Performing a long call is a straightforward process. The first step is to identify a stock that you are bullish on and feel confident of the stock’s price rapid appreciation in the near future.
Let’s make up a scenario where a long call would be a great option strategy.
Rewind a little bit to the end of 2020. We are in the midst of a pandemic and things are looking dire. Suddenly, there is a light. News breaks that top pharmaceutical companies, like Moderna, have discovered a vaccine with 100% effectiveness against COVID-19. Moderna just has to get through trials and FDA approval to get the vaccine in the hands of the general public.
If Moderna succeeds, chances are that their stock price will go through the roof. This is an opportune time to place a long call on Moderna.
To keep the math simple, let’s say Moderna was trading at $50 at the time the news broke. You had a strong sense that the stock price would grow if FDA approval came in the next month, so you placed a long call option that looked like this:
Current Price: $50
Strike Price: $53
Expiration Date: 1 Month
Premium: ($1*100 shares) = $100 premium
Over the course of the month, Moderna’s stock price rises and exceeds the strike price of $53 at expiration date. Your break-even price was $54, since you paid $100 for the premium, and now for every $1 the stock rises, you receive another $100 in profit.
In the view below, the stock rose to $61, giving you a $800 profit.
Incidentally, in reality, Moderna’s stock price went up $110 over the course of 3 months, so if you had purchased this long call and the stock price went from $53 to $173, you would have made a profit of $11,000.
The long call option is one of my favorites. It is easy to understand, has great profit potential and limited risk. We have been in a bull market for 13 years with only temporary corrections. We are poised to continue to see strong gains in the market with certain sectors in great position.
Make sure you do your research and understand the risks involved with any option strategy.