The long call and short call are option strategies that simply mean to buy or sell a call option.
Whether an investor buys or sells a call option, these strategies provide a great way to profit from a move in an underlying security’s price. This article will explain how to use the long call and short call strategies to generate a profit.
A call option is a contract between a buyer, who is known as the option holder, and a seller, who is known as the option writer. This contract gives the holder the right, but not the obligation, to buy shares of an underlying security at an agreed-upon price. The agreed-upon price in an option contract is known as the strike price.
Option contracts have expiration dates. This means that an option contract must be exercised before or on the expiration date. If an option contract is not exercised, then it will expire with no value.
If an investor were to implement the long call strategy, then he would buy a call option and assume the role of the option holder. This strategy would be used if the investor was heavily bullish on a stock and expected the stock’s price to rise significantly.
If an investor implemented the short call strategy, then he would sell a call option and assume the role of the option writer. This strategy would be used if an investor was heavily bearish on a stock and expected the stock’s price to fall significantly.
Let’s look at examples of the long call and short call strategies.
- Long Call Strategy: Assume stock XYZ has a price per share of $50. An investor buys one call option for XYZ with a strike price of $55 expiring in one month. He expects the stock price to rise above $55 in the next month.
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As the holder of the option, he has the right to buy 100 shares of XYZ at a price of $55 until the expiration date. One option contract is equal to 100 shares of the underlying stock.
Let’s assume the premium for the call option costs $2 per share. Therefore, the buyer pays $200 for the call option to the option writer. This amount is the maximum amount the buyer can lose.
Assume the price of XYZ rises to $60 in that month. Now, the buyer can exercise the call option and buy 100 shares of stock at $55, rather than $60. Once the option buyer buys the shares at $55, he can immediately sell them at the market price of $60. This generates a profit of $5 per share for the buyer.
However, if the share price never rises above the strike price of $55, then the call option expires, and the buyer is at a loss of $200 because of the premium.
- Short Call Strategy: Assume stock XYZ has a price per share of $50. An investor expects the price of XYZ to decrease within the next month.
The investor writes one call option with a strike price of $53 that expires in a month. The seller receives a premium of $2 per share, or a total of $200 for writing the call option.
Assume that within the month, stock XYZ never closes above $53. The option expires as worthless. The option writer profits $200 because of the premium.
However, let’s assume the share price did rise to $55 within the month. In this case, the option would have been exercised and the option writer would be obligated to sell the shares of stock at $53 rather than $55. That comes out to be a loss of $2 per share for the option writer.
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The long call and short call are both great strategies to use when an investor expects the price of an underlying stock to move either up or down. After having read this article, investors should feel prepared to begin buying and selling call options.