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 call can become profitable (the call is in the money, sometimes remembered as “call up”).
• If the stock’s market price stays below the strike price, the holder won’t exercise. In that case, the loss is limited 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 rises above $75 before expiration. If it doesn’t, the option expires and the investor loses the $600 premium.

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.

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

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, long calls don’t always end in a profit. The stock can rise above the strike price but still not rise 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 call 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. If the option expires out of the money, the investor paid a premium for a contract that is never used.

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 create a loss, the investor will let the option expire.

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

Investors can also perform closing transactions to exit 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: