Long calls

This chapter covers the fundamentals of long call options contracts. To get comfortable with the language used when discussing options, watch this video:

When an investor goes long a call, they’re bullish on the underlying security’s market price. Buying a call gives the holder the right (but not the obligation) to buy the stock at the strike price.

• If the stock’s market price rises above the call’s strike price, the holder can exercise and potentially profit. In this case, the call is in the money.
• If the stock’s market price stays below the strike price, exercising wouldn’t make sense. The holder will typically let the option expire and the loss is limited to the premium paid. In this case, the call is out of the money.

Let’s work through a few examples to understand long calls better.

Long 1 ABC Sep 75 call @ $6

This contract gives the right to buy ABC stock at $75 per share. Since one options contract typically covers 100 shares, the premium is $6 × 100 = $600. The contract expires on the third Friday in September.

The investor is expecting ABC’s market price to rise above $75 before expiration. If it doesn’t, the option will expire and the investor will have paid $600 for a contract they didn’t use.

Math-based options questions are common on the exam. They usually focus on potential gains, losses, and breakeven values. Let’s go through each.

A long call’s maximum gain is unlimited. The contract above allows the investor to buy 100 ABC shares at $75 any time before expiration. If the market price rises, the investor can exercise, buy at $75, and then sell at the higher market price. As the market price keeps rising, the potential profit keeps increasing.

$\text{Long call maximum gain}=\text{unlimited}$

For the following examples, assume the investor sells the shares immediately after exercising.

An investor goes long 1 ABC Sep 75 call @ $6. The market price rises to $100. What is the gain or loss?

Even if ABC’s market price rises above $75, the investor still might not profit. The increase has to be large enough to cover the premium.

An investor goes long 1 ABC Sep 75 call @ $6. The market price rises to $81. What is the gain or loss?

When investing in calls, the breakeven can be found using this formula:

$\text{Long call breakeven}=\text{strike price}+\text{premium}$

With a strike price of $75 and a premium of $6, the breakeven market price is $81 per share. At this price, there is no profit or loss.

If the market price doesn’t rise far enough above $75, the investor can still have a loss.

An investor goes long 1 ABC Sep 75 call @ $6. The market price rises to $79. What is the gain or loss?

Expiration is the worst-case outcome for a long option. If the option expires out of the money, it isn’t exercised and the premium is lost.

An investor goes long 1 ABC Sep 75 call @ $6. The market price falls to $73. What is the gain or loss?

Long options can only lose the amount paid in premium. If exercising would create a loss, the investor will typically let the option expire.

$\text{Long call maximum loss}=\text{premium}$

Investors can also close a long call before expiration by selling it (a closing sale).

An investor goes long 1 ABC Sep 75 call @ $6. After ABC’s market price rises to $79, the premium rises to $9, and the investor performs a closing sale. What is the gain or loss?

Here’s a visual summarizing the important aspects of long calls: