Long Call

Hi everyone! Ready to dive into options trading now that you know the basics?

Let's explore some fundamental strategies and how to pick the right ones for you.

Options can be divided into two types: call options and put options.

In terms of trading direction, investors can choose to buy to open (Long) or sell to open (Short).

Therefore, we have four basic option strategies:

Note: Opening a position means starting a new trade, while closing a position means ending an existing trade with an opposite action.

Simply put these four strategies fall into two categories:

Bullish/Non-Bearish:

Buying call options (Long Call)

Selling put options (Short Put)

Bearish/Non-Bullish:

Buying put options (Long Put)

Selling call options (Short Call)

While they can be categorized this way, each strategy has its own nuances. In this section, let's dive into the Long Call strategy.

I. Strategy overview

1) Strategy composition

If you believe that a stock will rise in the future, you can choose to buy a call option.

As the most basic single-leg option strategy, buying call options (Long Call) is commonly used and straightforward.

When the stock price rises, the price of the call option may also rise promptly, potentially leading to a profit.

2) Profit and loss analysis

3) Strategy characteristics

Unlimited Profit: The Long Call strategy has unlimited profit potential, as the stock price can theoretically rise indefinitely. Thus, when the stock price rises significantly, the investor's return generally also increases.

Limited Loss: On the downside, losses are relatively limited. If the stock price is not above the call option's strike price on the expiration date, the call option will expire worthless and the investor will only lose the initial premium paid.

Option Buyer Strategy: The Long Call strategy is an option buyer strategy, which means that you pay a premium when opening the position.

II. Case study

First, let's understand what options are. An option is a contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific time period. A call option gives the right to buy the asset, while a put option gives the right to sell it.

Here's an example to illustrate a call option:

Suppose on September 19, 2024, someone offers you a deal allowing you to buy 100 shares of Nvidia stock at $104 per share any time up to January 17, 2025. In return, you need to pay $23.50 per share upfront. If you ultimately decide not to buy the underlying shares, this $23.50 is non-refundable. Believing that Nvidia's stock might reach $130 or higher by then, you find this deal worthwhile. Thus, a call option contract is created.

Option Buyer (Rights Holder):

Pays $2,350 ($23.5*100) to acquire the right (to buy 100 shares of Nvidia at $104 per share any day before or on January 17, 2025). You may exercise this right or not, but the $2350 you paid will not be refunded.

Option Writer (Obligated Party):

Receives the $2,350 you paid and bears the corresponding obligation. If you decide to buy 100 shares at $104 per share at any time up to and including January 17, 2025, the seller must provide the shares and cannot refuse.

1) Contract elements

Using the Nvidia (NVDA) call option we mentioned above as an example, let's introduce the six key elements of an option contract

● Underlying Asset: The stock to which the option pertains, i.e., Nvidia

● Premium: The cost to purchase this option, i.e., $23.5

● Direction: Bullish (Call)

● Strike Price: The agreed price to buy the stock at expiration, i.e., $104.

● Expiration Date: The date on which the option contract expires, i.e., January 17, 2025.

After the expiration date, the option becomes invalid, and the holder can no longer exercise the right.

● Contract Multiplier: In the U.S., each stock option usually represents 100 shares of the underlying stock. However, in Hong Kong, stock options don't follow a fixed correlation and should be carefully monitored during trading.

2) Profit and loss analysis

Suppose you bought this call option at the closing price on September 19, 2024:

Note: Images provided are not current and any securities are shown for illustrative purposes only and are not a recommendation.

The opening cost: $23.5*100=$2,350 to buy one NVDA call.

Scenario 1: Stock price> call strike price + premiumSuppose on the expiration date, Nvidia's stock price rises to $150:You have the right to buy at the strike price of $104 as you paid a premium of $23.50 per share for this option.

So, your profit per share is $150 (stock price) - $104 (strike price) - $23.50 (premium) = $22.50. Since each option covers 100 shares, your total profit would be $22.5 * 100 = $2,250.Scenario 2: Strike price + premium> stock price> call strike price

Suppose on the expiration date, Nvidia's stock price rises to $125:

You have the right to buy at the strike price of $104 as you paid a premium of $23.50 per share for this option.So, your loss per share is $125 (stock price) - $104 (strike price) - $23.5 (premium) = -$2.5. Since each option covers 100 shares, your total loss would be $2.5*100=$250.

Note that the profit and loss calculations mentioned above are theoretical, and you can only confirm the final return when you sell the exercised stock.Scenario 3: Stock price < call strike priceSuppose on the expiration date, Nvidia's stock price is below $104:In this case, the option will not be exercised, and you will lose the entire premium of $23.5*100=$2,350.

III. How to set up a long call

Access the Options Chain:

• Tap on a stock > Options > Chain

Viewing Options:

• By default, options for the nearest expiration date are displayed. Click Call to view all call options.

• Slide the date bar to switch between different expiration dates. Weekly options are marked with a "w", while unmarked ones are monthly.

Understanding the Display:

• The blue area represents in-the-money options; the white area represents out-of-the-money options. The dividing line shows the current price of the underlying stock.

Analyzing Options:

• Click on an option to see a quick trade bar at the bottom. Click the upward arrow for a theoretical profit and loss analysis chart.

• Swipe left and right on the chart to see how different price points affect your return. It also shows estimated profit probability and breakeven points.

• Double-click on an option to enter the specific quotes page for more details.

• To buy the call option, click Trade at the bottom left to proceed.

Trade an Option

• Enter Trading Interface > Set Trading Direction and Price > Number of Contracts > Order Type > Click Buy

• The options trading interface is similar to the stock trading one, with the trading direction set to "Buy".

• Note: Options typically have a larger bid-ask spread, so you might choose a middle price based on the trading situation.

• Find purchased option contracts in Holdings > You can choose to sell to close/rollover/exercise the option.

IV. Applying the long call strategy

What are the common applications of the Long Call strategy in investment?

1）Leveraging small investments for potentially larger gains

When you buy a stock, you need to pay the full price of each share.

In contrast, when you buy a call option, you only need to pay the option premium, typically a fraction of the stock’s price. As mentioned above, each option typically represents 100 shares of the underlying stock.

You could gain exposure to potential stock price movements with a smaller initial investment.

This leverage effect allows you to control more assets with less capital, potentially yielding higher returns.

Here's an example:

Assume TUTU is a well-performing listed company, and its current stock price is $50 per share. You expect the stock price to rise to $65.

(Note: TUTU is not a real stock; it is used for illustrative purposes only.)

If you buy the stock:

Suppose you spend $5,000 to buy 100 shares. If the stock price rises to $65, your profit will be (65-50)*100 = $1,500.

Return on Investment (ROI): $1,500/$5,000 = 30%.

If you buy call options:

Suppose you buy a call option with a strike price of $55, expiring in three months. You pay a premium of $2 per share, totaling $2*100 = $200.

If the stock price rises to $65 at expiration, your profit will be (65-55-2)*100 = $800.

ROI: $800/$200 = 400%. This demonstrates the leverage effect.

When you buy stocks, the worst-case scenario is the stock price drops to zero, resulting in a total loss of your investment.

However, with the Long Call strategy, your maximum loss is limited to the premium paid.

Regardless of the stock's movement, you can't lose more than your initial investment in the option if you do not exercise.

This might make you wonder: if call options offer controlled risk and amplified returns, why buy the underlying stock at all?

It's important to note that returns from buying call options are more restricted; the stock price must reach your target within a specific time frame.

For instance, if TUTU's stock fluctuates or drops (remains below $55) within three months but reaches $65 afterward, holding the stock would still allow you to benefit from the price increase. However, the call option would have expired worthless.

Therefore, consider using this strategy only when you have strong confidence in the stock's upward movement within the specified period.

2）Hedging upward risks

Options are also commonly used as a risk-hedging tool. If you're bearish on an asset's long-term trend but worry about a short-term rebound, you can buy call options for protection.

For example, if you anticipate a significant drop in stock prices and decide to short the stock.

Short selling is the process of selling borrowed stock at the current price, and then closing the trade by purchasing the stock at a future time. If the price drops between the time you enter the trade and when you deliver the stock, you turn a profit minus any fees or expenses.

However, when short selling there is no limit on how high a stock price could rise, so the potential loss is unlimited. Other risks include dividend risk and margin risk. This strategy is not appropriate for all investors.

By buying an equivalent number of at-the-money call options while shorting the stock, you can help limit this risk with relatively small costs (the cost of the call options). This acts like insurance for your short positions.

But if the long call is not exercised and expires worthless, it no longer protects your short position.

V. FAQs

A. Is it better to buy cheaper calls?

Cheaper options usually have a lower probability of being exercised and are more likely to expire worthless.

Choosing the right option requires comprehensive judgment based on your investment goals, risk tolerance, and market expectations.

Premium = Intrinsic Value + Time Value

The intrinsic value refers to the outcome if you exercise it immediately (excluding the premium paid). Simply put, it is the current stock price minus the option's strike price.

For call options, only when the strike price is lower than the stock price does the option have intrinsic value; these options are called in-the-money options (ITM).

Call options with a strike price equal to the stock price are called at-the-money options (ATM), and those with a higher strike price than the stock price are called out-of-the-money options (OTM). Only ITM options have intrinsic value. They are usually more expensive than ATM or OTM options.

From the above equation, the option's value equals its time value for ATM and OTM Call options.

Time value decays as the expiration date approaches, eventually reaching zero on the expiration date. All else being equal, the farther the expiration date, the more expensive the option.

For option buyers, time is your enemy. If the stock price does not move in your favor within the specified time, you will usually incur losses.

B. Will the price of call options necessarily rise if the stock price rises?

Generally, if the stock price rises, the price of call options will likely increase. However, there are exceptions that involve understanding Implied Volatility (IV).

IV measures the market's expectations for future volatility. Generally, the higher the implied volatility of an option, the higher the premium will be.

With a predetermined strike price, increased volatility raises the likelihood of the stock reaching the strike price, thereby boosting the option's price.

Before major events like earnings releases or Federal Reserve meetings, volatility often rises; after these market-moving events, volatility typically drops quickly, lowering premiums. This is known as a volatility crush (IV Crush).

In such cases, you might see the stock price rise, but your call option's price increase may not meet expectations and might even drop in some instances.

When implied volatility is low, the premium is cheaper, meaning you can build a position with a lower initial investment.

Additionally, if you buy options when implied volatility is low and it subsequently rises significantly, your option's value might increase even if the stock price remains unchanged.

And it is advisable to select underlying stocks that have high trading volumes and good liquidity. This is because low liquidity can make it difficult to sell your options at your desired price, which can negatively affect your profitability.

C. Since the time value will eventually decay to zero, is it better to buy options closer to the expiration date?

The decay of an option's time value is nonlinear. As the expiration date approaches, the option loses time value more rapidly. Generally, an option's time value decays most quickly within the last 30 days before expiration.

While shorter-term options may seem cheaper, they require the stock price to move quickly to be profitable. Choosing too short a period could result in time decay eroding the value of your option quickly.

D. What can you do after buying call options?

The trading choices can be summarized into four types: closing the position early, exercising the option in advance, rolling the position, and holding until expiration.

Closing the position early: When the call option's price rise meets your expected return, you can consider selling it to lock in profits. Conversely, if the market trend deviates from your expectations, you might consider selling to cut losses. Your profit = (Premium at selling (sell to close) - Premium at buying (buy to open)) * Contract Multiplier * Number of Contracts.

Exercising the option in advance: This is almost always only done if the stock price is above the strike price. It is less common in practice because exercising early means forfeiting the option's time value.

Rolling the Position: This involves selling the current call option, realizing the profit or loss, and buying a new call option for the same underlying stock. This strategy reallocates time and price with the goal of managing risk or increasing profit.

For example, if you hold a call option expiring in three months but find that a major event likely to drive the stock price up will occur in six months, you can roll the position by choosing a longer-term option.

Conversely, if you expect the catalyst for the stock price increase to occur within one month, you can close your position and purchase a shorter-term call option.

Holding until expiration: If the option is out-of-the-money at expiration, the option will expire worthless, and you will lose the entire premium paid.

If the option is in-the-money at expiration, the option will be automatically exercised.

Automatic exercise conditions:

• US Market: If the underlying stock price exceeds the strike price by $0.01 or more at the close of the expiration date.

• Hong Kong Market: If the underlying stock price exceeds the strike price by 1.5% or more at the close of the expiration date.

If your account has sufficient buying power, the system will automatically exercise the option, allowing you to buy the corresponding number of shares at the strike price. If your account does not have sufficient buying power and you have not closed the position or added margin, the system will forcibly close the position.

Therefore, it is crucial to monitor your account's funds to avoid unnecessary losses due to insufficient purchasing power. You can check your account's status by clicking Accounts > Risk Status.

If the call option is held until expiration and does not reach the strike price, the option buyer does not need to take any action. The system will automatically void the option and send a notification, and the option will no longer appear in your holdings, with the paid premium lost.