With so many option strategies out there, a trader can be overwhelmed at times, especially during volatile periods. They will hear things like “you have to be able to trade spreads if you are going to make it trading options” or “professional option traders only sell options.” Option traders might be inclined to never look at buying call options again if they believe everything that is said. This famous saying applies here: “Don’t believe everything you hear.” In this article we’ll share a couple of great reasons buying calls should not be overlooked, but first here’s a brief look at what a call option is.

Call Option

The call option is probably the first thing a new option trader learns. The buyer of a call option has the right and not the obligation to buy an underlying asset at a certain price before a specified time. The buyer of a call option pays a premium to have this right. It basically allows traders to speculate in stocks they do not own. In general, buyers of call options have a bullish outlook on the stock. The price at which the owner can buy the stock is called the strike price. A trader has a specified time in which to exercise his or her right to buy the shares. That day is referred to as the expiration day. There are usually multiple expiration times available for options.

Delta

An option’s delta measures the rate of change in the price of the option relative to the change in the price of the stock. Simply put, delta will tell a trader how much the call will increase or decrease in value based on a dollar move in the stock. For example, if a call option has a delta of 0.60 and the stock increases by $1, the call option premium should increase by $0.60. If the stock fell in price by $1, the call option premium should decrease in price by $0.60.

How a Call Option Works

Say a trader thinks a stock is going to increase in price. The trader can buy a call option instead of buying shares of the stock. XYZ shares are trading at $35. One choice a trader has is to buy 100 shares of the stock for $3,500 (100 X 35). If the stock goes up $1, he will make $100 on his investment. Another choice a trader has is to buy a call option. A long call can profit almost like shares of stock and for far less money. He could buy a July 30 call for 5.00 with a current delta of 0.90, which would cost $500 (5 X 100 shares) and would profit $90 for every $1 the stock moved up until July expiration. The call gives the trader the right to buy 100 shares for $30 a share. One of the nice things about buying a call option is that a trader never has to buy the shares. He can simply sell the call option in the market basically the same way it was bought.

What a Call Option Can Do That a Spread Can’t

A spread trade such as a bull call spread is buying a call option and selling a higher strike call option with the same expiration. One advantage it might have over buying a call option is that it can lower the cost of the trade since a call is both bought and sold. The major disadvantage of a bull call spread is that maximum profit is capped because of the sold call (the owner has the right to purchase shares at the strike price). But being just long a call option has unlimited profit potential. The stock can continue to rise and the owner of the call will always have the right to buy the stock at the strike price no matter how far the stock increases. This can come in handy especially if a trader has a bullish outlook on a stock and maybe the stock has no overhead resistance. There is no telling how much the stock may continue to go higher so why would a trader want to implement a bull call spread and possibly limit his or her profits? Buying a call option can take advantage of unlimited stock move to the upside.

Example

During a previous trading period, Apple Inc. (AAPL) was trading at around $170. A trader purchased the January (Jan 19th) 175 calls for an ask price of 2.30. AAPL was trading just above a potential support area around $169 and had bounced and moved higher from that point previously. A week later, the stock was trading just above $176 and the January 175 calls had a bid price of 4.45. Both the delta (due to gamma) and the implied volatility increased, which also raised the call’s premium. A profit could have been made of $2.15 a contract with the stock moving just over $5 higher. The same could not have been said if a spread like the bull call (maybe the January 175/180) was implemented because of the smaller delta.

Conclusion

Many option traders already know that options can provide leverage for greater investment returns. But sometimes they can get caught up trying to implement an advanced option strategy or make adjustments to take advantage of a possible opportunity when maybe the best strategy is simple. The long call is probably the first option strategy they may have learned and, for many, it’s one they have not thought about since.

John Kmiecik, Market Taker Mentoring