Buying (Long) a Call Option:
A basic option strategy to be familiar with and learn the advantages and disadvantages of is buying a Call Option (Long Call). Buying a call option is the opposite of buying a put option, in that a buying a call gives you the right, but not the obligation to buy the underlying futures contract at a specific strike price. When you buy or go long a call your outlook is “bullish” the market and you expect a rise in the underlying asset price.
Steps to Trading A Long Call
Buy or go Long the Call Option
Remember that for futures option contracts in the U.S., one option contract is for one futures contract. So when you see a price of .20 cents for a Put option for Corn, you will have to pay $1000 for that option. (.20 cents x 5000 bushels = $1,000), plus any commissions or fees.
A few points to consider:
- As an Hedger if you feel prices may go higher and you have already sold some or all of your “Physical” (grain, livestock, crude oil, etc.) and you would like to participate in any upside rally in prices if it were to occur, using no margin, then a call option is probably the way to go. The reason being is three-fold. If you do buy a call option and prices do in fact go higher, then your call option will rise in value, partially offsetting the missed profit you would have made if you hadn’t sold your “Physical”. Second, if you are an entity or individual that uses and needs a physical (ethanol plant (corn), Airline Company (fuel), wheat miller (wheat), candy maker (sugar or cocoa), and need to protect your bottom line profit against rising prices before you have to purchase the underlying commodity then buying a call option is a way to do this instead of buying the futures contract and being at risk of margin calls. If prices do rise before you physically purchase the commodity then the long call option will partially offset the higher prices you will have to pay. Thirdly, if prices do fall, your call option (s) will lose more or all of their value but you will be able to purchase your physical at this lower price which will more than offset your loss in the call option (s). Plus you are not using margin to do this, and your risk is limited and a known factor.
- Buying a Call option is a net debit transaction, because you are paying for the call, your maximum risk is capped to the price you pay for the call, and your maximum reward is uncapped and unlimited as prices could “hypothetically” rise to infinity.
- *Time decay works against your bought / long call option. Give yourself plenty of time. Don’t be fooled into a false sense of security of thinking that buying shorter term, cheaper options are better. Compare a one month option to a 12-month option and divide the longer term option price by 12. You will see that you are paying far less per month for the 12-month option.
Advantages and Disadvantages
- Protect or Profit from a rise in the underlying price of the asset.
- Uncapped and unlimited protection or profit potential with “capped risk”.
- A potential 100% loss of the premium paid.
- An option will not trade 1 for 1 with the underlying. Depending on what Put option you buy, let’s say that the underlying asset makes a price move of $1.00, your call option may only move .70 cents, depending on the Delta*, which is dependent on your strike price.
Definition of Delta – Movement of the Option price relative to the movement of the underlying asset (futures contract). A Delta is a numerical number (ex: 0.52) which gives us an indication of the “speed” at which the option price is moving relative to the underlying asset (futures). Therefore a Delta of 1 means the option price is moving 1 point for every 1 point the futures price is moving. Typically, an at-the-money option has a Delta of 0.50 for calls and -0.50 for puts, meaning that at-the-money options half a point for every 1 point move in the futures contract. Delta is another way of expressing the probability of an option expiring In-The-Money or ITM.