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 Long calls
Issued on August 04 2010 par Strategies-options.com
One of the very first strategies using options consists in purchasing calls
Purchasing calls is one of the two pillars in order to understand option trading
I - A context An underlying, which can be a stock for example, that is worth today 100 is likely to rise over the next 3 months up to 115 according to our feeling / analysis. We want to benefit from this movement in order to make money and one thus needs to consider the different ways to reach that goal. II - At least two possibilities 1 - One can directly buy the stock on the market. Indeed there will be money earned if the rise happens. On the other hand, there could be a loss if the stock falls. 2 - Another way is to buy a 6 months call struck at 100, an option which allows purchasing the stock at 100 6 months from now, if it’s sensible. That option is now worth $ 4. 6 months later, if the stock is worth for example 115, the call would be exercised and transformed into a stock that would be bought for 100. One can then immediately sell the stock back on the market for 115 and make a profit of 115 - 100 = $ +15 for each call previously owned. The final net profit would be 15 - 4 (payoff minus the call premium) = $+ 11. In the case where the stock dropped to 60 at the end of the 3 months, there would be no interest has to exercise the call, and it would be abandoned. One would prefer to buy the stock on the market for 60. The break-even is then strike price+premium thus 100 + 4 = $ 104 Graphically it comes:   III - Summary Purchasing a call is a bullish strategy which makes possible to risk a small premium in case our expected scenario wouldn’t be the right one. Next : Long Put Previous : Simple Definition Of What An Option Is Download the pricer here BASIC OPTIONS STRATEGIES - INDEX BASIC OPTIONS STRATEGIES - CHAPTER I BASIC OPTIONS STRATEGIES - CHAPTER II BASIC OPTIONS STRATEGIES - CHAPTER III BASIC OPTIONS STRATEGIES - CHAPTER IV Strategies-options.com |
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