What's a Long Call Option
2013-04-02
by Greta Dorce
A long call option gives the buyer of the option the right to purchase a stock at a given price for a defined period of time.
A simple example:
- A stock is selling today for $50 per share.
You buy a long call option for $5.- The option gives you the "option" to purchase that stock anytime in the next 90 days at $50 per share.
Why would you want to buy a long option call instead of just purchasing the stock?
Well... The one word answer would be "leverage."
Example where stock price goes to $60 within 90 days:
- If you bought the stock at $50 and sold at $60 you made $10.
Investment $50 Return $60 Profit $10
- If you spend the $50 on long option calls you have purchased the option to buy 10 shares,($5 per option X 10 options = $50). So if you exercise your option you get to buy 10 shares of the stock
for $50 and sell them for $60.
Investment $50 Return $100 Profit $50
That's great! Why would anyone want to buy the stock for $50 and make $10 if they could buy the long option for $50 and make $50?
Well... The one word answer would be "risk."
That extra $40 profit comes with a load of risk. You have only 90 days to execute your option with the stock price at $55 or higher to break even or make a profit. If you do not execute your option within 90 days it expires... worthless!
Example where stock price drops to $40 and you never execute your options within 90 days:
- If you bought the stock at $50 and sold at $40 you lost $10.
Investment $50 Return -$10 Loss $10
- If you spend the $50 on long option calls you have purchased the option to buy 10 shares,($5 per option X 10 options = $50). You never exercise your option because the stock has dropped from $50 to $40.
Investment $50 Return -$50 Loss $50
As you can see the leverage you gain with a long option call comes with a great deal of risk. If the stock does nothing for the term of the option you lose all your investment. But if you were certain that a stock was going to take off in the near future and you wanted to maximize your profit then the long call option is the way to go.
