Buying a call option is called long call. A trader does a long call when he expects the stock prices of an underlying to rise.
Profit
Long call strategy makes profit if the stock price at expiration is above the strike price plus the premium paid. Long call profits from the increase in volatility by increasing the time value option. Profit potential is unlimited.
Loss
If the stock price at the expiration is below the strike price plus premium paid this strategy will lose its value and trader will prefer not to buy this call option contract at maturity. Here premium paid plus commission paid is the maximum loss. When the underlying price goes up and volatility decreases and lowers the time value of the option, this position can also lose value
Time Decay
If the stock does not move up, then the option will lose all its value by expiry date. This happens due to decay of premium of the option called time decay.
Price Sensitivity (Delta)
Time Decay (Theta)
Volatility Sensitivity (Vega)
Example:
Suppose Apple stock (AAPL) price at NASDAQ is at 100 USD and expectation is that it will move up to 120 USD in next few weeks. To make profit from this expected rise in stock price, you buy N quantity of AAPL stock @ 100 USD. Your, this action is called Long Call on APPL stock.
After buying a call, its position can be closed as follows:
- Selling the call – Call brought by the buyer can be sold at any time thus closing the position.
- At Expiry – On the day of maturity, call gets expired and its value becomes zero. On this expiry day if the call is ITM, you will make profit and if it is OTM, its useless and you will get nothing.
- Exercising the call – When you buy few stocks based on your right to buy, you get shares of stock at the strike price
Formulae for Long Call:
- Profit = Price of underlying – Strike Price of long call – Premium paid
- Profit making starts when Price of underlying >= Strike Price of Long Call + Premium Paid
- Loss making starts when Price of Underlying <= Strike Price of Long Call
- Maximum profit = unlimited
- Maximum loss = Premium Paid + Commission paid