June 14, by Brian Mallia. Investors will typically buy call options when they expect that a underlying's price will increase significantly in the near future, but do not have enough money to buy the actual stock or if they think that implied volatility will increase before the option expires - more on this later.
A call is an option contract that gives the purchaser the right, but not the obligation, to buy stock at a certain price called the strike price. If the stock goes up, the value of the call contract also goes up. If the stock goes down, the value of the call option goes down. Think of buying call options like this, keeping in mind that this is a slightly simplified example:.
You have an inclination that GOOG ticker symbol for Google is going to increase quite a bit because they have a new product rolling out. Buying one call option contract allows you to control shares of stock without owning them outright, for a much cheaper price. Because you don't have enough money to exercise the option, you would choose to take the profits and close the trade out.
Unlike owning stock which has no expiration , owning a call could result in either a full loss of the call's value, or unlimited profit potential at expiration. The purchaser is not obligated to buy the stock at expiration because they can sell the call at any point in time as long as the underlying is liquid enough.
The drawback of owning a call is that there is no long-term residual value. Now that you understand the basics of buying call options, let's dig into how the purchase of a call option affects the amount of money in your account aka your buying power. In a brokerage account, the buying power reduction of buying a call is equal to the debit cost paid to put on the trade. Buying power reduction is equal to the debit paid for the trade as seen on the tastyworks trading platform.
Now, let's take a look at when your long call will be profitable and when it will expire worthless. A long call can be purchased in the money or out of the money, which I will explain next.
Below is an example of buying a call option that is 'in the money' ITM. The math looks like this: A variation of this is an 'out of the money' OTM long call option, which works the exact same way.
See the below example for a visual. This holds true for both in the money long call options as well as out of the money long call options. The price at which a loss on a long call option will occur is shown in the tastyworks platform above.
Now that you grasp when a long call will be profitable and when it will lose money, let's discuss the ideal conditions for placing a long call option. The debit paid the price paid for the option will be less for underlyings with a low IV rank as opposed to a high IV rank. As implied volatility increases, the market is indicating a greater expected range of the movement in the underlying. Therefore, option sellers demand a higher premium because underlyings with a high IV rank are much more likely to have larger price shifts and vice versa.
The exit strategy depends on the goal of the investor, but for investors who do not have the capital required to buy the stock, options 1 and 2 are the only options no pun intended. With a long call option, you will not automatically be assigned stock. At any point, you have the right to exercise the long call and buy the shares agreed upon when undertaking the option contract, but you do not have to exercise this right.
If you have additional questions about long calls, drop it in the comments sections or shoot our support team an email at support tastytrade. Most investors are familiar with what earnings are, but less know about the different strategies and considerations when investing in a company with upcoming earnings.
In this post you will learn about what earnings are, the terminology associated with earnings, and how you can place an 'earnings trade. Strike price is an important options trading concept to understand. This post will teach you about strike prices and help you determine how to choose the best one. Long Calls - Definition Investors will typically buy call options when they expect that a underlying's price will increase significantly in the near future, but do not have enough money to buy the actual stock or if they think that implied volatility will increase before the option expires - more on this later.
Think of buying call options like this, keeping in mind that this is a slightly simplified example: Buying Power Reduction In a brokerage account, the buying power reduction of buying a call is equal to the debit cost paid to put on the trade. An ITM long call option as shown in the tastyworks platform. An OTM long call option as shown in the tastyworks platform. IV Rank as displayed on tastyworks' trade page.
Closing the Trade To close a long call, an investor can do one of three things: Exercise the long call - receive shares of stock at the strike price of the option.More...