long call option

Long Call Option

The Long Call is the easiest bullish strategy out there. You buy the right but not the obligation to purchase the stock for a pre-determined price.

Only that you won’t be buying any stock because you’re likely to lose some of the profit, you’ll just sell the call. Exercising the call is feasible if you are unable to sell.

It will be a good idea to check on it at least daily. Options can be a fast moving product and you don’t want to miss out on a massive profit because you forgot about it and it expired worthless.

Call options expire worthless quite often so you need to have a very strong conviction of a sharp increase in the share price.

The Long Call is set-up by sending a buy order for 1 call options contract at your chosen strike. You get a theoretically unlimited profit potential for a limited loss:

long call option
Payoff at expiration of an at-the-money $50 strike call option in a theoretical stock trading for $50

Long Call Delta

There are no hard rules about the option’s Delta. However, the probability of profit will increase the closer your strike is to the stock price. Unfortunately, the price of the call will increase too.

On balance something like 30 Delta is expected to be more profitable than 5 Delta.

Regardless, it depends on the market conditions. It’s obvious that you’ll make a killing if your 5 Delta call ends up in the money.

Gamma

You’re long Gamma which is great because it compounds your gains. Let’s say you have a 30 Delta option with a Gamma of 3. A $2 up move will give you 6 additional Deltas.

One of the most fascinating facts about Gamma is that it increases the closer you get to expiration:

DTE 1 means 365 days, thus 0.1 means 36.5 days. The plot includes both puts and calls

So we’re faced with a dilemma, do you buy a longer expiration to take advantage of time or a shorter one to buy cheap Gamma?

Personally, I favour a longer expiration because I feel that the value for money is better. However, others prefer to get more Gamma on the cheap.

You need to find your own way around this just make sure you appreciate that the high Gamma comes with high time decay. Nothing is ever free.

This brings us to a major risk of the long call: spending too much money on short duration out of the money calls. The result is a blown account.

Vega

You’re long Vega so you have two revenue streams: share price appreciation and volatility increase. Therefore, it’s best to purchase the call when Implied Volatility (IV) is low.

For example, the stock is trading for $50 and you buy a $50 call at an IV of 60% for $3.70. The stock goes up to $52 10 days later. However, the IV goes down to 45% and your option is now worth $3.53 even though it’s in the money.

Volatility can work against you! This emphasises an important point: ensure you don’t overpay for volatility.

There is a good chance for a call to expire worthless so I prefer to get the maximum duration I can. Sometimes the next expiration cycle can give you more time for little additional premium.

Volatility is related to Theta so if the IV is high your time decay will be high.

There’s more, the call’s Delta will be higher too because of a second-order Greek called Vanna. It depicts the relationship between Delta and Vega. This is another reason to make a purchase when the IV rank is low.

It’s easier said than done. Volatility represents both risk and opportunity. Sadly mathematics don’t recognise the difference between the upside and the downside.

You can’t have it both ways so the call price is low when the opportunity for profit is low.

One thing to look out for is to avoid purchasing low Delta calls prior to earnings announcements. The IV crush will wipe you out.

Another way to manage this is to buy a long duration because the post-earnings cycles will be less affected by the volatility crush.

Theta

Time decay is your worst enemy! The call will expire eventually no matter the duration. Day after day Theta chips away from your premium. It starts to gain traction around 60-70 days prior to expiration and explodes the last 20 days.

But it’s not just that, there are the second-order derivatives Charm and DvegaDtime. We can go on forever, till the 8th-order derivative and beyond, but we’ll settle for these for practical reasons. You’re not a market maker otherwise you wouldn’t be reading this.

Charm a.k.a. Delta bleed is pretty straight forward, you lose a small bit of the option’s Delta as each day goes by. It’s understandable that your Gamma will bleed too.

They say that everything disappears in the ashes of time so DvegaDtime will chew up your Vega.

You don’t need to calculate these but you’ll notice them for sure, I promise. They are all connected and work against you in sync while your option is out of the money.

It works differently when the option is in the money. We won’t discuss that because I assume it won’t matter since you’ll sell the call for profit.

A stock’s expected move

Here’s how it works. Imagine the time cone of the stock’s expected move. I’d anticipate a wider range over 252 days compared to 40 because of the longer period of uncertainty. Who knows what may or may not happen?

Let’s try to visualise this with a Monte Carlo simulation. This is the expected move of SPY over the next 40 trading days on the left and 252 on the right:

You can see that the 252 day range is indeed much wider. However, as time goes by the range will become narrower because events will move from the future into the present and then the past (or the other way around).

This makes some future paths less and less probable because the market adjusts its expectations based on the realised one. For example, there is a 53% probability that SPY will increase in value tomorrow and 47% that it will decrease. The realised probabilities will be 1 and 0 once the event has moved to the past.

So if the stock trades flat the time cone will get narrower as time goes by. Your out of the money call will move further and further away from the money. I could argue that the time cone will be moving away from the call but this is pointless because you’ll lose your premium either way.

Long call management

There is not much to manage if we stick to a single leg. My own preference is to let the call expire worthless, I write off the premium at the time of purchase. Others may choose to close it to retain at least some of the premium. There is no right or wrong way of doing it.

You need to build your own mechanics and trade in a way which suits your personality and risk preference.

Long calls are great for speculative stocks because you invest less capital. In the imaginary $50 strike call example all you can lose is $370. Compare that with the maximum loss of $5,000 from 100 shares. The only problem is that whenever the stock is risky the options premium is quite high too. Choose your calls carefully.

Some argue that calls are more risky than stock. But then it all depends on the cases you pick. I can give you examples of stocks which crashed and never recovered all day long.

This emphasises the point that case selection is very important because the risk of losing your premium is substantial. Otherwise, why would anyone agree to sell you a call in first place?

Strategy conversion

The long call gives you the flexibility to advance your position to a different strategy. However, you need to calculate your potential profit or loss with great care.

Opportunities like that are few and far between so this section is only meant to improve your options trading awareness.

For example, you can sell a higher strike call and turn the strategy in a long vertical spread. The only way this will work is if you bought a cheap call and it appreciated in value, then you sell a higher strike call.

There’s no need to overcomplicate things so you are likely to be better off if you sell the original call.