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 are 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 potentially profit by exercising the option (“call up” - the call is “in the money”).
• If the market price stays below the strike price, the holder won’t exercise and will realize a loss equal to the premium paid (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. The option costs $600 ($6 × 100 shares) and expires on the third Friday in September.

The investor is betting that ABC’s market price will rise above $75 before expiration. If it doesn’t, the option will expire worthless, and the investor will have paid $600 for a contract they never used.

Math-based options questions should be expected on the exam. They typically ask about 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. The higher the market price goes, the larger the potential gain.

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

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?

Can you figure it out?

Even though the maximum gain is unlimited, a long call doesn’t automatically produce a profit just because the market price rises above the strike price. The increase has to be large enough to cover the premium.

Let’s try another example with the same option:

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 investor breaks even when ABC stock is at $81 per share. At this market value, there is no profit or loss.

If the market price of ABC doesn’t rise far enough above $75, the investor can still have a loss even though the option is in the money. For example:

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 scenario for investors holding long options. When a long call expires out of the money, the investor loses the entire premium.

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 spent on the premium. If exercising would result in a loss, the investor will let the option expire.

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

Investors can also perform closing transactions to close their options before expiration.

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: