Skip to content

Long Call

Where the investor expects the price of the underlying stock to rise, the bought call can provide leveraged exposure to the price rise. Buying a call also locks in a maximum purchase price for the life of the option.

When to use the long call
Market outlook bullish
Volatility outlook rising

Payoff diagram

long call payoff diagram

The long call
Construction long call X
Point of entry market around X, but can vary
Breakeven at expiry strike price + net premium paid
Maximum profit at expiry unlimited
Maximum loss at expiry limited to premium paid
Time decay hurts
Margins to be paid? no
Synthetic equivalent long stock, long put X

Profits and losses

The maximum loss the investor can suffer is the premium paid for the option, which will occur if the share price at expiry is below the strike price. The investor breaks even if at expiry the share price is equal to the strike price of the option plus the premium paid. As the share price rises beyond this point, the potential profits of the bought call are unlimited.

Other considerations

  • Time decay: time decay works against the buyer of the call. If the expected share price rise does not take place soon after entering the position, time decay will start to erode the value of the option.
  • Strike price: the investor will usually have a choice of strike prices, and must balance the cost of the option against the rise in share price required for the strategy to be successful. The out-of-the money option will be the cheapest, but also requires the largest rise in share price. Many investors regard the at-the-money option as offering the best balance of risk and reward.
  • Expiry month: a longer-term option allows more time for a rise in the share price to take place, but will be more expensive than a shorter-term option. The investor needs to form a view of the time frame over which the share price movement is expected to take place.

Follow-up action 

If the share price rise takes place as expected, the call option taker must decide whether to close out at a profit, or maintain the position in the hope of a further increase in price. The longer the option position is left open, the greater the effect of time decay.

If the share price does not rise as expected, it is often advisable to close out the position in order to recover some time value from the position.

If at expiry the option is in-the-money, the investor must choose whether to sell the option or exercise it. The choice will be determined by whether the investor wants to own the underlying shares.

Points to remember

  • Only buy calls when you expect the share price to rise, and volatility to increase.
  • Be realistic in selecting a strike price - the out-of-the-money option will be cheapest, but also requires a large move in the share price for the strategy to be profitable.
  • If the expected share price rise does not eventuate, be prepared to take a small loss by exiting the position, rather than holding on until expiry and possibly watching your option expire worthless.

Example

After trading in a narrow range for several months, XYZ Limited has broken through a chart resistance point. You believe the share price will run up from current levels of $4.00 to $4.50 or more over the next two months. You decide to buy an at-the-money call option.

Buy 1 Nov $4.00 Call @ $0.25

long call payoff diagram

Disclaimer
The information contained in this webpage is for educational purposes only and does not constitute financial product advice. ASX does not represent or warrant that the information is complete or accurate. You should consider obtaining independent advice before making any financial decisions. To the extent permitted by law, no responsibility for any loss arising in any way (including by way of negligence) from anyone acting or refraining from acting as a result of this material is accepted by ASX.

Market news

Source: Source DowJones View all Market news