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Long Call Option Strategy - Options Trading Strategies - Bullish Options Strategies - YouTube
Channel: Option Alpha
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Hey everyone.
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This is Kirk, here again at optionalpha.com,
and we're going to talk about the most basic
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option strategy that there is.
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Really, the foundation of every other strategy
out there, or this is one of the foundational
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building blocks.
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And that is a long call option.
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It's probably the most widely used, widely
traded at the beginning with beginner traders.
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So, we're going to go over that in detail
in this video.
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So, starting with the market outlook.
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A long call option is a strategy that you
implore when you think that the stock prices
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are going to rise significantly beyond the
strike price before expiration.
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So again, this is a very bullish strategy.
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You're looking to buy a call option on a stock
and see the stock rise much, much further
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than your strike price.
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And what that does is that allows you to actually
buy the stock at the strike price, and then
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sell it back to the market (if you so choose)
at the higher market price.
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So again, this is going to give you a tremendous
amount of leverage with regard to the market
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compared to buying these shares outright.
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The call option is going to give you the power
to control 100 shares of stock for just one
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call option.
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So, you could in effect, trade 10 call options
and control 1000 shares of stock.
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It'd be much cheaper to buy the option than
it would be to actually buy the stock outright.
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Now, how do you set this up?
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These are very easy to set up.
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It's just a single leg option order.
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So, what you're going to do is simply buy
a call option with a strike price and expiration
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period that you desire.
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So, you can buy these at various strike prices,
in the money, out of the money, at the money
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strikes.
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And you can also buy them at various expiration
periods, depending on what your outlook is
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for the stock.
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If you don't think the stock is going move
until next month, well, then maybe you'll
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buy an option for the following month or for
two months beyond there, just to give yourself
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some extra time.
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But it's very easy to set up.
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It's just a single order that you place in
your broker platform.
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Now, the more bullish you are, the further
out of the money you can buy the call option.
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So, let me explain.
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Like we talked about before, for you to make
money on this strategy, it has to be much,
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much further than your strike price at expiration.
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So, if the stock is trading at let's say 30,
right here where my cursor is, and you're
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really, really bullish on the stock, you could
buy a call option at say 40, right here where
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this call option pivots.
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And that's a 40 strike.
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So, this means that you're really bullish
and you think the stock is going to move beyond
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$10 by expiration for you to start to make
money.
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Now, this option is going to be cheaper than
if you let's say for example, bought an option
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while the stock was trading at 40.
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You bought the 40 strike which is at the money,
so an at the money call option.
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It's going to be a little bit more expensive
because it doesn't have as much distance to
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move before it starts making money.
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So again, you can buy these at different ranges.
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But the more out of the money you are, the
more bullish you are on the stock.
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What's the risk?
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Well, the risk is on all options that you
buy, long options is completely capped at
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the premium that you pay for that option.
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So, if you hold the call all the way till
expiration and the stock never moves higher,
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then where it was when you entered and it
never moves into a profit range, then you'd
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be looking at an option that's going to lose
just the value of the premium that you paid
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for that option.
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So sometimes, traders will pay as little as
$10 for an option.
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And that's the most risk that they have.
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Now, the good thing is that the profit potential
of these are theoretically unlimited.
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A stock can rise to infinity.
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It really has no upper boundary.
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But at some point, the contract is going to
reach parity which means that it's going to
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act just like the stock.
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If it continues to rise so far so fast, it's
going move just like the stock, and you're
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really going to lose that leverage that you
have, so you might as well convert it.
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But for all intensive purposes, the profit
potential for long calls and more or less,
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long puts is very, very much unlimited.
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You have a huge potential with minimal risk.
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Now, volatility is going to be an important
factor with regard to long call options.
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Generally speaking, on increase in implied
volatility, it's going to have a positive
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impact on this strategy, everything else being
equal.
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So, if general market volatility increases,
that's going to tend to boost the value of
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these options because there's a greater chance
that the stock may swing into a profitable
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range.
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During low volatility times where the stock
is trading let's say, right around 40, there's
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not that high of a likelihood that it's going
to swing wildly between 50 and 30.
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So, if it's trading right around 40, low volatility,
then there's not that high of a probably that
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it's going to move into your profit zone.
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So as always, at the money options are going
to behave differently than something that's
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out of the money.
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Obviously, if the stock is trading at $20
and our strike here is at 40, then this is
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going to be a wildly out of the money option,
so even a big volatility move may not even
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impact this option.
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So, you just have to look at different volatility
pricing factors.
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And as always, check some of the other video
tutorials that we have to learn more about
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volatility and options.
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Time decay is going to be also an important
factor for long call options.
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We all know that options have a finite life,
right?
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That's expiration.
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It's the point at which they stop trading
and you have to make a decision on whether
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you want to get rid of the option or exercise
it or have it assigned.
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So, every day that passes that this option
doesn't make money, it's losing money, it's
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losing value, it's getting close to that expiration
period, it's kind of like it's withering away.
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So, we want to trade this on a stock that
is going to move.
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A stock that doesn't move is not going to
be profitable for this type of strategy, and
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that's because the time decay value is going
to continue to disappear and degrade the value
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of the option throughout the expiration cycle.
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If at expiration, the stock is anywhere below
your strike price with a long call, then you're
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going to lose all of your premium that you
outlaid.
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And again, that your max loss.
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If at expiration, the stock is above your
strike price, then you're going to make the
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difference between the stock price and your
strike price.
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And then again, factoring in your premium
that you paid for the option.
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So again, let's talk about that breakeven
point right now since we were on it.
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Again, like we were talking about, at expiration,
the strategy will breakeven if the stock price
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is equal to the strike price, plus the initial
cost of the call option.
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So, all you're going to do is take the strike
price of the long call.
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In our case, that's $40.
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It's right here where the option payoff diagram
pivots.
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And you're going to add the premium that you
paid.
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In our case, $200.
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That's the premium that we paid for this option.
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That creates our breakeven period.
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That's when we start to not make money on
the strategy, right?
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So, that's the period that we want to watch
on the chart.
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That's where the stock has to move beyond
by expiration.
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Let's look at an example again just to drive
home the point.
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So, let's say that the stock price is trading
at $40.
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We're going to buy one 40 strike call, and
that's going to be right at the money.
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So, we're going to buy an option right at
the money here, and we're going to pay about
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$200 for that call option.
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So, that $200 is going to be a debit on the
trade, meaning that that money is going to
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come out of your trading account.
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You're going to pay that price and receive
that option.
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Now, your max loss on the trade is only $200,
right?
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That's the cost of the option.
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You can't lose any more than that.
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And again, here's the best feature, and that's
your max profit.
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Your max profit is theoretically unlimited
because the stock price can rise to whatever
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price.
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Now again, this is much different than if
you traded the individual stock.
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If you bought the stock at 40 outright, your
max loss would be if the stock goes all the
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way down to zero.
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Here, the stock can crash to zero and you
still only lose your $200 investment.
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Some tips and tricks regarding long call options.
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This is a very popular strategy.
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And again, it's the building block for other
complex strategies.
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So, it's really important that you understand
how a call option works independently of everything
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else.
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And this is really a key feature here with
call options.
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It's that you don't have to understand how
single leg options work.
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It's that when you start overlapping them
with other options, (let's say short calls
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and short puts and long puts and long calls)
then you understand how they all work together.
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But it's important that you understand how
just the basic building blocks work with regard
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to volatility in time decay like we've gone
over here.
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I always tell people to tend to focus on the
at the money or slightly out of the money
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call options when you're buying for speculating.
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If you're going to buy a call option to hedge
a short position in the market, then you want
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to focus on things that are more out of the
money, and therefore, cheaper, right?
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You don't want to pay such an expensive price.
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But if you're going to speculate on the direction
of the stock, i.e. you think that the stock
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price is going to move up considerably, focus
on buying options that are at the money or
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slightly out of the money.
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They're going to be a little bit more expensive,
but they're also going to make money quicker.
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Some of those options that are deep out of
the money that are $5 and $10, although they
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look really attractive on a price level, meaning
that they're really cheap pricewise, they're
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cheap for a reason.
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And that reason is because they don't have
a high likelihood of making money, so they're
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not going to be expensive.
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Nothing has value that's that cheap.
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So again, focus on these options that are
around the current stock price when you're
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trading.
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So as always, I hope you guys enjoyed this
video, and thanks for watching.
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