The long call option strategy is perhaps the most commonly used and often is the most commonly misused as well. On the options basics page, I talked about why this strategy is risky, however it doesn't always have to be that way. I will actually look at two different ways to trade thist strategy.
To want to trade a long call, I must be bullish on the underlying stock, ETF or index. In fact, I typically want to be quite bullish or it may make sense to trade a different strategy, such as a short put vertical spread.
One thing I like about the long call strategy is that my risk
limited ultimately to the price I paid initially. I can
certainly limit this further by using a stop loss. This
strategy offers a nice amount of leverage since the cost is relatively
small, yet I can take advantage of strong upside moves in the
For the long call strategy, I prefer to find stocks that have shown a history of sustained moves and may be also showing evidence of changing trends from bearish to bullish or resuming a previous bullish trend.
For the purpose of this discussion, I'll use AMZN, which has been in a pretty bullish pattern recently. It shows some evidence of strong moves when it does move up.
AMZN recently closed at $62.35 and looks to be forming a bull flag. As a result, I might expect a further movement at least to $67.50 or even a breakout to new highs.
Since the long call strategy depends on a strong, relatively quick move up in the price of the stock, I prefer to catch the stock near a support bounce or right as it breaks through a previous resistance point.
Before placing the trade, let's first do some analysis of various trading approaches. I mentioned earlier that I would discuss two different ways I trade a long call. One is deep in-the-money (ITM) and the other is out-of-the-money (OTM). On the previous page, I briefly showed an example of trading an OTM call, but I want to go into more analysis detail here.OTM strategy
Why is this appealing to me? First because I am less impacted by the passage of time and changes in volatility. Second because there is less risk if AMZN goes nowhere for the next two weeks.
Before placing any trade, it is important to analyze risk and reward. If the risk is too great for the expected reward, then it doesn't really make sense to take the risk.
With the ITM trade, if I assumed the same move of AMZN potentially down to $57.50, my ITM option would be worth approx $8.26, which means I lost about $5 or about 37% of my investment. So in this case, my reward/risk would be $3.65/5 or .73:1... potentially not too good unless I was right a lot with this strategy. And... with the long call strategy, I'm not right as often as I'd like.
Once I've selected my option, it's time to place the trade right? Whoops! How many contracts will I buy? That will depend on how much I am willing to risk.
You must decide BEFORE placing the trade how much you are willing to risk.
That plus the choice of option and my exit strategy will help determine how many contracts to buy.
In this example, for this trade, I am willing to risk $1000. Further, I will allow a stop loss on the option such that I exit if my option value drops to 50% of the original purchase price. That means $.78 for the OTM option and $6.60 for the ITM option. Knowing that 1 option contract controls 100 shares, my calculations would be:
OTM: $1000/(.$78 x 100) = 12.8 or 12 contracts. However, 12 contracts will cost $1884.
ITM: $1000/($6.60 x 100) = 1.5 contracts ... or 1 contract. One contract will cost $1320.
OK. I know which option I will buy, how many contracts and at what price I'll exit. I must be ready to place the order.
Some online brokers designate opening orders differently than closing orders. To open the long call trade, I might place the order as 'buy to open' 12 contracts of the March 70 call for an offer price of $1.57.
As I mentioned, I want to make sure I have determined in advance what the exits are for this trade. For a long call trade, I like to have three key exits planned.
This last one puts a time constraint on the trade that allows me to exit a trade early if the pattern I expect doesn't develop.
For the first two, I have already determined to use a 50% stop loss for the worst case scenario. If the trade goes as expected, I may simply chose to close the trade when AMZN reaches $67.
Many online broker platforms allow you to place a 'one cancels other' order such that you can place both orders simultaneously - one to get you out with a profit and one to get you out with limited loss. With this kind of order, whichever order gets hit first, the other will be canceled.
I've learned the hard way that the best way to consistent profits is to have a process I follow consistently. This is true for a long call or any other strategy.
With the long call strategy, it is possible to make money from a strong bullish move of AMZN. Because of the leverage options offer, I could realize a better gain from an options trade than with stock. However, leverage goes both ways. Time is against me with a long call.
Notice that as I've discussed the various steps to trading the long call, I've followed a fairly structured approach (selecting the right stock, timing the entry, selecting the right options, entry, exit, etc). These are based on a set of trading rules I follow, which are part of an overall option trading system I follow. This is a critical aspect of successful options trading. I've found I can't be successful trading any strategy just by knowing the mechanics. Having a system that defines what I do every time I trade is what helps me be consistent in my profits.
|Outlook:||Near term to medium term bullish|
|Max Loss:||Cost of the option (but you can limit with a stop loss)|
|Time decay effect:||Works against you|