Buying a Call Option
| B/S | Strike | Type | Price |
|---|---|---|---|
| Buy 1 | $45 | Call | $1.29 |
| Net Debit | $129 | ||
A long call option gives the buyer the right to buy the underlying asset at the strike price. The option buyer pays a premium for this right to the seller of the option.
The Max Loss will only ever be the premium that is paid up front to buy the option.
The Max Gain is uncapped and will rise with as long as the underlying price rises.
Characteristics
When to use: When you are bullish on market direction and also bullish on market volatility.
A long call option is the simplest way to benefit if you believe that the market will make an upward move and is the most common choice among first time investors.
Being long a call option means that you will benefit if the stock/future rallies, however, your risk is limited on the downside if the market makes a correction.
From the above graph you can see that if the stock/future is below the strike price at expiration, your only loss will be the premium paid for the option. Even if the stock goes into liquidation, you will never lose more than the option premium that you paid initially at the trade date.
Not only will your losses be limited on the downside, you will still benefit infinitely if the market stages a strong rally. A long call has unlimited profit potential on the upside.
Long Call Greeks
Delta
Gamma
Vega
Theta
201 Comments
Timatao May 18th, 2015 at 7:52am
Hello Peter
More info. The large block traded at .65 ( I believe the stock price was around 51 at the time). The option did expire barely in the money. I believe the actual close was 52.55. The aftermarket was the interesting point when 999k traded at 52.61. So the market maker who sold the calls did owe the stock at expiration. Normally aftermarket trades 3-4k shares so the big block was unusual.
Peter May 17th, 2015 at 10:17pm
Hi Timatao,
The seller of the calls would have been a market maker(s) for sure (being on the ask when the trade occurred) and with such a large trade would have been hedged with stock at the time of trade. But regardless of that, the call was out of the money on the expiration date so there wouldn't have been anything to cover as the option expired worthless meaning the seller keeps the premium. As the option's delta approached zero the market maker would be selling stock to keep delta neutral so perhaps the last block was what they had left to offload? Hard to say, but seems a reasonable guess.
On the buy side though...I see that earnings were out on the 23rd April. Seems the buyer had some good info prio to the announcement? The options were looking good for a while after the release - the stock went from 47.72 on the 22nd April to 51.51 (+8%) after the announcement on the 23rd and then 54.03 on the 24th. Hard to say how much they would have made on the premium though as I don't know where they bought it - maybe they paid 0.20, 0.30? At 54.03 it's intrinsic value alone makes the option worth at least 0.53 though.
Another reason to buy the calls so aggressively around that time (in addition to the expected price rise) might be to receive the dividends. The previous ex-date for DNKN was on the 5th March (div of 0.265) with a payment date of 18th March. Perhaps they bought the calls before the ex-date to qualify for the dividend, exercised the options to take delivery of the stock before the ex-date, waited for the stock to jump and sold the stock and still received the dividend on the payment date?
DNKN Dividend History
DNKN Earnings Information
Timatao May 16th, 2015 at 3:51pm
Peter
Wanted to get your insight on May expiration on DNKN 53.5 call options. A big player purchased 16k contracts and paid the ask price a couple months back. I think the stock is undervalued so I purchased some of the same contracts and sold some 55 against.
The expiration was interesting as there was still 13k open interest on the last day. The stock traded up to 52.5 at the very close and then in the after hours a 999k block traded at 52.61. Did the seller of the calls not have the ability to cover and somebody covered his position at 52.61? This was such a large block I was wondering why somebody would do that if they wanted the stock? and what is your opinion of what this could mean for price action going forward?
Timatao
Dennis April 24th, 2015 at 2:56am
Hi Peter,
The reason why you should not exercise ITM calls early (except in some cases prior to dividend) is you give up the interest value included in the price (I know, not very much nowadays with rates close to zero).
Also, if you want to maintain your bullish/long position, by exercising you create more risk because you basically swap your 100%-delta call with stock... and because the stock will have a higher price than the call, you potentially lose more.
If you do want to exercise your calls early, please check any residual time value/premium left... if there is any, it's better to sell.
D
Peter November 3rd, 2014 at 5:28pm
Hi SG,
I'm not sure why someone would say that premature exercise is not a good idea. If the stock is approaching its' ex-dividend date and you want to receive the dividend, then you would definitely exercise early to ensure you're holding the stock through the ex-date to be eligible to receive the dividend.
But if your call option is making a profit and currently ITM then I see nothing wrong with squaring it off by selling the same amount of contracts back to the market to realize the profit.
If you were instead to exercise the option first, you would be utilizing more capital to take delivery of the stock position before selling the stock back to make the profit.
SG November 1st, 2014 at 6:35pm
Why is it said that premature exercise is not usually good? If I am ITM, and current premium is 100% ( or a higher multiple of 100%), would I not make money by selling the call? Is that what one means by squaring off the position?
Peter October 29th, 2014 at 5:50pm
Hi Warren,
Why sell it? If you're only going to receive one cent for it you may as well hold onto it - you have another 3 months for the position to fatten in value. Plus, your brokerage costs for selling at one cent may actually be more than the value received by selling.
If I were you I'd just hold onto them; it's too small value for selling considering the time there is left in the option.
AVP have their earnings out before market open tomorrow too - let's see what happens after that.
Warren October 29th, 2014 at 11:04am
I have AVP 20 Jan 2015 calls which are worthless. How do I take the loss in 2014 (nearly $20,000) as there is no market for them even for .01? I use ETrade and they told me to just try selling each day at market. Considering the stock is now only $11, no one will be buying!
Peter October 24th, 2014 at 4:18pm
Hi Rony,
It's a difficult question to answer as it depends on just how bullish you are and what the delta of the option is (i.e. how much the price of the option will change relative to changes in the underlying price).
If the option is very close to expiration then an ATM option will be more attractive than an OTM option.
However, if there is decent time to go then an OTM option will most likely provide the highest return on investment (premium paid) provided the underlying makes a decent move upwards.
The best way to understand though is by simulating moves in the underlying and checking the theoretical imapact it has on the prices of the options. You can use my option pricing spreadsheet for this.
Give it a go and let me know how you go and if you have any questions.
rony October 22nd, 2014 at 6:06am
Let's say, for instance, I want to maximize my profit with a call option of a stock I'm pretty sure will go up tomorrow. Let's say I don't mind the risk. Which call option should I buy? One that is exactly ATM? One that is slightly OTM?
Thanks!
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