Option Strategies: Long Call & Short Call

Greetings, fellow finance enthusiasts and curious minds! Today, we embark on an exciting journey to unravel the mysteries of option derivatives. If you've ever found long calls, short calls, long puts, and short puts puzzling, you're in the right place. These option strategies can be complex, leaving even the most dedicated students scratching their heads. However, fear not! In this blog, we will break down the concepts of Long call and Short call piece by piece, until they become crystal clear. So, let's roll up our sleeves and embark on this enlightening adventure together!

Option Basics:

Before delving into the strategies, let's recap the basics. An option is a financial contract that gives the holder the right (but not the obligation) to buy (call option) or sell (put option) an underlying asset at a predetermined price (strike price) on or before a specified date (expiration date).

1) Long Call:

A long call is a bullish strategy where the investors purchase a call option. This means they have the right to buy the underlying asset at the strike price before the expiration date. By going long on the call, the investors hope the asset's price will rise, allowing them to earn profit from the price difference.

Understanding Profit and Loss:

Suppose Mr. Bilal is bullish on the shares of Company ABC, currently trading at $1000 per share. He believes that the stock price will rise significantly in the next few months due to a new product launch.

To profit from this potential price increase, he decides to execute a long call strategy. Here's how it works:

He bought call option (from Mr. Junaid) on Company ABC at a Premium of $50 per share with strike price of $1200 and expiry date of 2 months from now.

At expiration we have following scenarios:

• Share trading at $1500 and Bilal has a right to buy the share at $1200, so obviously he will exercise the right.

Profit:

Share Price - Exercise Price - Premium Paid = $1500 - $1200 - $50 = $250

Note: Share price can increase up to unlimited price therefore as price increase profit will also increase up to unlimited amount.

• Share trading at $1000 and Bilal has a right to buy (not an obligation to buy) the share at $1200, so he will not exercise right.

Profit/(Loss):

Premium Paid = ($50)

Note: As share price decreases from exercise price, Bilal will not exercise the option and his maximum loss will be the amount of Premium paid.

• Share trading at $1250 and Bilal has a right to buy (not an obligation to buy) the share at $1200, so he will exercise the right.

Profit/(Loss):

Share Price - Exercise Price - Premium Paid = $1250 - $1200 - $50 = 0

Note: When share price is equal to exercise price plus premium paid so it will be Breakeven point (point when there is no gain or loss).

2) Short Call:

A short call is the opposite of a long call and involves selling a call option. The seller (also known as the writer) is obligated to deliver the underlying asset to the buyer at the strike price if the buyer exercises their right. This strategy is typically employed when the investor believes the asset's price will remain stable or decrease slightly.

Understanding Profit and Loss for Mr. Junaid:

• Unlimited loss potential if the share's price rises significantly (Case 1 when Bilal has unlimited profit)
• Limited profit up to amount of premium received ($50 as above) from the buyer of option right (Mr. Bilal).
• Breakeven at share price of $1250.

Choosing the Right Strategy:

The choice between these option strategies depends on an investor's market outlook and risk appetite. Bullish investors might prefer long calls while short calls are typically employed by those seeking to generate income from option premiums but come with higher risks.

Conclusion:

Congratulations! You've made it through the maze of option derivatives - long call, and short call (Long put and short put will cover in next blog). Armed with this knowledge, you now have a foundation to explore and engage confidently in the fascinating world of options trading. Remember, practice and continuous learning will solidify your understanding of these strategies, so keep exploring and honing your skills.

Options are powerful financial instruments that offer flexibility and potential for significant profits, but they also carry inherent risks. As with any investment, it's crucial to conduct thorough research, seek guidance from financial professionals, and consider your risk tolerance before diving into the world of options trading.

Happy investing, and may your financial journey be filled with prosperity and knowledge!