Long Calls
Risk: limited
Reward: potentially very high
General Description
Entering a long call position simply entails buying call options…preferably ones that are in-the-money.
The Thinking
If you are very bullish a stock, you can buy the stock or you can buy a call option which grants you many of the same benefits of owning the stock at a fraction of the cost. But what you gain in leverage you lose with time. Whereas a stock can be held indefinitely, options have an expiration date. So the stock doesn't just need to do what you think it will do, it needs to do it within a specified time frame.
Example
Let's say MSFT is trading @ 55, and you think it will rally in the next few weeks. You could buy 1000 shares for $55,000, but instead you buy (10) 55 call options for $2.50 ($2500) that expire next month.
If the stock rallies to 57.5, you will break even. For every point above 57.5, you will profit $1,000, so a huge rally could bring you a huge profit (remember we said you get the benefit of owning the stock without actually buying it). If the stock goes nowhere, the calls will expire worthless and you will lose your entire investment. Your max profit is theoretically unlimited because the stock can rally indefinitely, and your max loss is locked in place as your initial capital outlay.
The image below summarizes the trade with a P/L Diagram. |
