Looking to profit when a stock or other investment increases in value, but you don’t want to pay the full price? Then you may want to consider options. More specifically, here’s what you need to know about long call options.
What is a long call?
Call options are financial contracts that provide the option buyer the right to buy an underlying asset, such as a stock or exchange-traded fund (ETF), at a set price called a strike price.
On options contracts there are 2 sides to the transaction: The option buyer and options seller. When trading a call option, the option buyer acquires a contract from an option seller. Purchasing the call gives the buyer the right to buy an asset at a specific price, known as the strike price, by an expiration date. If the price of the underlying asset doesn't meet or exceed the call strike price before the expiration date, then it is unlikely the buyer will "exercise" the contract and buy the asset. If the price of the underlying asset does meet or exceed the strike price, then the buyer has the right to buy that asset for the previously agreed upon strike price. To obtain the contract, the option buyer pays the option seller a fee called the “options premium.”
A long call is an option strategy where you buy a call option. The general goal is for the underlying asset to increase in value so that you can either exercise the option contract if it is in the money (as in, the underlying stock rises above the strike price before the contract’s expiration date) or sell the option contract for a profit before it expires. If the asset’s value meets or exceeds the strike price, then you’ll be able to purchase that underlying asset at that strike price, which could be less than the current market price of the asset.
Why would you want to buy a call option? Because you’re hoping the price of the underlying asset rises above the strike price (plus the cost of your premium) and you’re able to snag the shares you want for a discount compared to the market price.
For example, you might decide to buy a call option with a strike price of $50 that lets you buy shares for that price, even if that investment rises to $55, $60, $100. Really, any amount over the strike price could make a call option a worthwhile buy.
What's more, your maximum risk is limited. No matter how far the stock declines, even all the way down to $0, you can only lose the premium paid for the long call contract.
Example of a long call
Ready to see how all of this might play out in a hypothetical example?
Suppose you’re interested in buying shares of Company XYZ, which currently has a share price of $90. On the option chain, which displays premiums and strike prices for different timeframes through your brokerage, you find a contract (which controls 100 shares) with a strike price of $120 that expires in 90 days. The cost, or premium, is $3 a share for each option contract (1 contract x 100 shares x $3 = $300 total).
After purchasing 1 contract, you now have the right (but not the obligation) to purchase the underlying shares at the strike price before the expiration date. If at any point over the next 90 days, XYZ’s share price rises above $120, you have the right—but not the obligation—to buy 100 shares by exercising the option. If the price reaches $130 a share, for instance, you still pay $120 per share ($12,000), making a gross profit of $1,000 ($10 of profit per share above the strike price x 100 shares). But don’t forget about the $300 you paid as the option premium, meaning your net profit is $700 ($1,000 profit - $300 premium).
Alternatively, if XYZ’s share price falls to $80 a share, for example, you aren’t out anything more than the $300 option premium. Long call options don’t obligate the buyer to purchase any underlying shares if the stock doesn’t exceed the option strike price. If you already owned the shares, instead of simply having a long call option on them, you would have lost $1,000 in value (a $10 decrease per share x 100 shares).
Although you can hold an option contract to its expiration, you can also sell an option contract prior to its expiration to realize a profit or minimize a loss.
Note: These examples don’t include any commissions or fees that may be incurred, as well as tax implications, which all could potentially subtract from profits further.
Benefits of long calls
If you’re thinking about implementing a long call strategy, here are 2 main benefits to keep in mind:
- Uncapped potential profit: In theory, a long call could provide unlimited profit. Provided the strike price is met, it allows you to pay just the value of the strike price (plus any premiums and fees) for assets that could increase substantially in value. It’s worth noting that uncapped potential profit is also the case for owning the underlying stock in the first place.
- Less risk than owning an asset outright: The most you’ll lose when holding a long call option is the premium you paid for the contract (plus any applicable fees or commissions). If you own an asset outright, meanwhile, there’s the potential its value could fall to $0. Of course, the value of a long call can fall to $0 also, but losing 100% of the option contract is almost always less total money than losing 100% of the value of owning the stock outright.
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That’s because long call options let you do more with less: a financial concept broadly known as “leverage.” Because long call options allow you to lock in the right to buy an asset at a certain price for much less than it would cost to own it outright, you can potentially benefit from its price rising without tying up a significant chunk of money to do so. This allows you to use funds you’d otherwise spend owning shares of something in other ways, like gaining exposure to other companies, industries, or investment types.
Disadvantages of long calls
If you’re going to buy a long call, make sure to understand these 2 downsides:
- Your option may expire worthless: There’s no guarantee that the price of the underlying asset will reach or exceed the strike price, allowing you to make a profit on your option contract. With any option contract, there’s a real risk that it will expire worthless, and you’ll be out your option premium.
- There are downsides to leverage: Although an option contract grants you exposure to potential price changes less expensively than owning a stock outright, that increased exposure also has a downside. First, option contracts force you to give up many of the benefits from owning the shares outright, such as dividends, or voting rights. Additionally, because option contracts can expire worthless if you’re wrong about your outlook, your loss buying an option can be bigger than if you were to own the stock outright. Generally, with any investment where you are trading with leverage, when you're wrong about your outlook, your potential losses are amplified.
How to buy long calls
If you’re interested in buying call option and implementing a long call strategy, follow these steps.
- Open a brokerage account with option trading capabilities
To trade option, you need a brokerage account with option trading capabilities. If you don’t already have a brokerage account that allows for this, research potential fees and commissions that financial institutions charge to trade option before opening an account with them. Once you’ve got a brokerage account you can trade option with, don’t forget to fund it. That’s what will allow you to buy long calls.
- Apply to trade options
At many financial institutions, you much apply in order to trade options. At Fidelity, you must first complete an options application and be approved to trade options before you can buy long calls.
- Research investment options and place a trade
As with any investment decision, you’ll want to fully research any asset you’re hoping to buy a long call for. Once you have a stock or ETF in mind, you may want to explore option-specific research tools, like Fidelity’s Option Strategy Builder which can help you build and place an option trade.
You may also check out your brokerage’s option chains. After you find a combination that works for you, you can start buying long call option contracts right on the option chain.
Before executing any option trade, make sure to fully consider the strategy’s risks. Option trading should only be executed by those with full knowledge of the potential drawbacks.