Buying a call option is the most basic options strategy. The investor pays a premium to buy the contract and, in exchange, the call option gives them the right to buy (or call), the underlying stock (futures, ETF, index, etc) at a specific level (strike price) through a set date (expiration month). Premiums are quoted as bids and asks and are constantly changing along with the prices of the underlying.
If the strike price of the call is higher than the current level of the stock price, the contract is out-of-the-money [OTM]. A call is at-the-money [ATM] when the strike price equals the underlying price. The option is in-the-money [ITM] when the underlying stock is trading above the strike price. A common call strategy is to buy an OTM call and ATM call and hope the underlying moves beyond the strike price and into being in-the-money.
If an option is in-the-money at expiration, it can be exercised to take delivery of the stock at the price stipulated by the contract (strike price). However, the call option can be closed out at any time prior to the expiration through an offsetting transaction. For instance, if I bought 10 Jan 50 calls on XYZ, I can cover the position by selling 10 XYZ Jan 50 calls.
Buying a call is typically a bet that the price of the underlying will move higher, but it is also a way to hedge a short position. Time will negatively affect the position due to the fact that options have set expiration dates and the value of the contract decreases with passage of time. Changes in implied volatility can have an important impact on premiums as well. In a typical long call purchase, the magnitude of the move higher in the underlying asset must be sufficient enough to offset the negative impact from time decay and/or any decreases in implied volatility. Increasing implied volatility will help the long call position.
Since the multiplier for listed equity options contracts, the cost to buy a contract equals the current market price X 100. For example, if June 25 calls on Facebook are trading for $1, it costs $1000 to buy 10 contracts (10 contracts X $1 X 100 multiplier). The position can be closed (all or partly) by selling FB Jun 25 calls to offset. If held through the expiration and the price doesn’t move north of $25, the entire debit is lost. The breakeven on a Long Call at expiration is the strike price plus the debit, or $26 (25 strike plus $1 premium). There is theoretically no limit to the profit potential from a long call strategy. Many investor use it as an alternative to buying the underlying shares when they want to lock in the right to take a position, but don’t want to stick their necks out too far.
LONG CALL EXAMPLE: BUY 10 Facebook (FB) JUNE 25 CALL @ $1
Bias = Bullish play looking for the stock to strengthen through the June term.
Breakeven = Call strike + call premium: 25 + 1 = 26
Risk = Limited to the amount paid for the call: $1 per contract, or $1000
Reward = Unlimited as the underlying price moves above the breakeven.