Buying (long) call options

Purchasing calls has remained the most popular strategy with investors since options were introduced. Before moving into more complex strategies, an investor should thoroughly understand the fundamentals about buying and holding call options.

Break-even price : Strike Price + Premium Paid

Break-even price : Strike Price + Premium Paid

Bullish to very bullish.

This strategy appeals to an investor who is generally more interested in the dollar amount of his initial investment and the benefits of leverage that buying calls can offer. The primary motivation of this investor is to make a much greater profit trading options for a given increase in price of the underlying security.

Experience and precision are key to selecting the right option (expiry and strike price) for the most profitable result. In general, the more out-of-the-money the call is the more bullish the strategy, as bigger increases in the underlying stock price are required for the option to reach the break-even point.

As Stock Substitute
An investor who buys a call instead of purchasing the underlying stock considers the lower dollar cost of purchasing a call contract versus an equivalent amount of stock as a form of insurance. The uncommitted capital is "insured" against a decline in the price of the call option's underlying stock, and can be invested elsewhere. While holding the call option, the investor retains the right to purchase an equivalent number of underlying shares at any time at the predetermined strike price until the contract expires.

Note: Equity option holders do not enjoy the rights due stockholders - e.g., voting rights, regular cash or special dividends, etc. A call holder must exercise the option and take ownership of the underlying shares to be eligible for these rights.

Maximum Profit: Unlimited
Maximum Loss: Limited
Net Premium Paid
Upside Profit at Expiry: Stock Price - Strike Price - Premium Paid
 

Your maximum profit depends only on the potential price increase of the underlying security; in theory it is unlimited. At expiry an in-the-money call will generally be worth its intrinsic value. Though the potential loss is predetermined and limited in dollar amount, it can be as much as 100% of the premium initially paid for the call. Whatever your motivation for purchasing the call, weigh the potential reward against the potential loss of the entire premium paid.

If Volatility Increases: Positive Effect
If Volatility Decreases: Negative Effect

Any effect of volatility on the option's total premium is on the time value portion.

Passage of Time: Negative Effect

The time value portion of an option's premium, which the option holder has "purchased" by paying for the option, generally decreases, or decays, with the passage of time. This decrease accelerates as the option contract approaches expiration.

At any given time before expiry, a call option holder can sell the call in the listed options marketplace to close out the position. This can be done to either realize a profitable gain in the option's premium, or to cut a loss.

At expiry, most investors holding an in-the-money call option will elect to sell the option in the marketplace if it has value, before the end of trading on the option's last trading day. An alternative is to exercise the call, resulting in the purchase of an equivalent number of underlying shares at the strike price.