The long call strategy involves buying a call option, also known as "going long." It's a straightforward approach betting that the underlying stock will rise above the strike price by the expiration date.
Consider XYZ stock trading at $50 per share. A call option with a $50 strike price and a six-month expiration is priced at $5. Since each contract represents 100 shares, buying this call costs $500 ($5 premium x 100 shares).
| Stock Price at Expiration | Long Call's Profit |
|---|---|
| $80 | $2,500 |
| $70 | $1,500 |
| $60 | $500 |
| $55 | $0 (Break-even) |
| Below $55 down to $20 | -$500 (Loss limited to the premium paid) |
The upside of a long call is potentially infinite until expiration, as the profit grows with the stock's price increase. The downside is the total loss of the premium, $500 in this case, if the stock does not perform as expected.
A long call is suitable for those looking to wager on a stock's increase with limited risk. It offers a way to gain exposure to stock price increases without the full cost of owning the stock directly, limiting downside risk to the cost of the call option.
The covered call is a two-part strategy where an investor owns the underlying stock and sells a call option on that stock. This approach aims for income generation by collecting the premium while betting the stock price will stay flat or decrease slightly until the option expires. The investor risks losing potential stock appreciation above the strike price but limits the downside risk.
With XYZ stock at $50 per share, an investor can sell a call with a $50 strike price for a $5 premium, receiving $500 for 100 shares. The investor must own at least 100 shares of XYZ to cover this call.
| Stock Price at Expiration | Call's Profit | Stock's Profit | Total Profit |
|---|---|---|---|
| $80 | -$2,500 | $3,000 | $500 |
| $70 | -$1,500 | $2,000 | $500 |
| $60 | -$500 | $1,000 | $500 |
| $55 | $0 | $500 | $500 |
| $50 | $500 | $0 | $500 |
| $45 | $500 | -$500 | $0 |
| $40 | $500 | -$1,000 | -$500 |
The maximum profit of a covered call is limited to the premium received. While the strategy caps upside potential, it provides a buffer against stock depreciation, with the downside risk being the total loss of the stock's value, mitigated by the premium earned.
Covered calls are popular for generating income on stock holdings with limited downside risk. It's suitable for investors who expect the stock to remain flat or decrease slightly, allowing for income generation or setting a desirable sell price for the stock.
The long put strategy is an investment approach where you purchase a put option, betting on the decline of the stock's price below the strike price by the expiration date. Unlike the long call, this strategy capitalizes on a stock's potential decrease.
For XYZ stock at $50 per share, a put option with a $50 strike price and six months to expiration can be bought for a $5 premium per share, totaling a $500 investment for a contract covering 100 shares.
| Stock Price at Expiration | Long Put's Profit |
|---|---|
| $60 | -$500 |
| $50 | -$500 |
| $45 | $0 (Break-even) |
| $40 | $500 |
| $30 | $1,500 |
The maximum gain for a long put is theoretically the strike price times 100 per contract if the stock falls to $0, offering significant profit potential. However, the risk is limited to the loss of the entire premium, $500 in this scenario, if the prediction is incorrect.
A long put is suitable for those willing to risk the premium to profit from a stock's decline. It offers more substantial earnings potential than short-selling, with a clearly defined risk. This strategy can be particularly appealing for limiting losses compared to the unlimited risk of short-selling.
The short put strategy involves selling a put option, or "going short," betting that the stock will not decline significantly before expiration. This strategy benefits the seller if the stock price stays the same or rises, allowing the put to expire worthless and the seller to keep the premium.
If XYZ stock is trading at $50 per share, a put with a $50 strike price can be sold for a $5 premium, netting the seller $500 for a contract covering 100 shares. The profit or loss for the short put is the inverse of a long put.
| Stock Price at Expiration | Short Put's Profit |
|---|---|
| $70 | $500 |
| $60 | $500 |
| $50 | $500 |
| $45 | $0 (Break-even) |
| $40 | -$500 |
| $30 | -$1,500 |
The maximum profit for a short put is limited to the premium received, $500 in this case. If the stock price remains above the strike price, the seller keeps the premium. However, if the stock falls below the strike price, the seller incurs a loss, with the maximum downside being significant if the stock goes to $0.
Investors might use short puts to generate income or to enter a stock position at a desired lower price. While the strategy provides an opportunity to earn premium income or buy a stock at a discount, it carries the risk of substantial loss if the stock price declines.