Long Call vs. Short Call vs. Protective Call: Decoding Options Strategies for Beginners
Long Call:
A long call strategy is a bullish investment approach in the options market. When traders believes that the underlying will go up significantly, they buy only call options, is called long call.
When you buy a call options contract, it gives you the right but not the obligation to buy the specific stocks (underlying) at a specific price (Strike Price) by a certain time (Expiry date).
This is different from directly buying the stock. A long call mean, you are essentially betting that the stock price will increase significantly by the expiration date.
Pros:
Limited Risk: Risk is limited for the buyer. Maximum loss is only the premium the buyer paid for the call options.
Leverage: Calls offer leverage, which means buyers can potentially control a larger number of shares than they could afford to buy outright. This magnifies buyers gains if the stock price rises significantly.
Lower Upfront Capital: Compared to buying the stock itself, buying calls require less upfront capital.
Cons:
Time Decay: The value of a call option decreases over time, even if the stock price stays flat. This is called time decay. Sometimes value of the call options may decrease even if the stock price rising but slowly, normally this thing happen with ATM and OTM call options. Mostly ATM and OTM buyer faced this risk of losing money even if the stock rising slowly.
Unexercised options expire worthless: If the stock price doesn't rise above the strike price by expiration, your call option expires worthless, and you lose the premium you paid.
When To Buy A Call Options
Traders buy a call options when the believe the underlying price will rise faster, that mean they wait for for perfect technical scenario before they long a call option. let's discuss the technical scenario today, perhaps this will help you to understand better.
Buying After High Volume Rally Followed By Low Volume Re-test
This is the best price action trading strategy for buying a call options, where buyers of the options can by-pass the options greeks and or options chain in their trading but still they can make handsome return than others.
See the picture below for understanding.
Exhibit 1
In the picture available left side is the ideal technical scenario for long call.
You can see while underlying was moving up, it had a huge volume, this volume indicates, most probably professional traders has started buying the stock. Then low volume re-test refers that, most probably amateur traders selling their stocks. So you can say here big traders are bulls and retail traders are bear, in this fight, the chances of wining is much much higher for the bulls.
Traders wait for trend line break out or long CMO, or anyother price action formation before they long a call option.
Buying Near The Bottom Of A Big Green Candle
Another excellent technical scenario to long call option is buyig the call when the underlying price is approaching it's previous big green candle's bottom, here traders expect a sudden and faster reversal in price.
See the Picture below for understanding.
In the picture right side we can see a big Green candle with huge volume. This indicates most probably institution buying has been started in the stock or underlying.
Now traders strat tracking the stocks, after the large candle, stock may re-test the origin of rally, or may simply move away or may become sideways.
If the stocks fall and reach the origin or nearby area of the origin of rally, traders gain an extra advantage of lowest stop loss and high probability entry opportunity.
They can convert the chart into lower time frame and buy call option after Long CMO or Piercing Pattern or Hammer or any other price action patterns.
Exhibit 2
Buying Call Options After Positive Divergence Of RSI
One of the most beautiful technical scenario to long a call option when underlying price making lower low and RSI making higher high. After the positive crossover traders gain an extra edge of low risk and high probability trading.
See the picture below to understand.
Exhibit 3
In the picture left side, you can see that price making lower low and RSI (Green Line in picture) making higher low. It is positive divergence between price and RSI.
Traders wait for a positive crossover, once the green line overlap the Red Line (9 Day exponential moving average of RSI), trader get the confirmation of long.
This divergence may occur in Daily chart, hourly chart or 15 minutes chart.
Professional traders prefer buying call options after positive divergence as it represent low risk and higher reward.
There are many more other technical buying scenario offers Long Call Option Strategy opportunity, if you want to learn professional options buying you must learn proper technical analysis with price action trading strategy. At Dronakul we can help about this.
Strike Selection:
In case long call, strike selection is most important part after technical analysis. Already I have mentioned earlier that traders may lose money even if the underlying moving up but slowly if they purchase ATM or OTM call options.
Therefore professional trader focus to buy little Deep ITM Call Option with Delta > 0.8
Breakeven:
If you hold the options overnight you must know the breakeven point as the time value will decreases overnigt.
Breakeven Point For Call Option = Strike Price + Premium Paid
Maximum Loss:
Maximum loss is limited, only the premium paid could be the maximum loss.
Maximum Profit:
Maximum profit is undefiened
Why Most People Lose Money In Long Call
There are many reason of losing money in long call optons
- Bad timing to buy the call
- Buying after a significant rally
- Buying low priced call option (Buying OTM, this is the biggest reason)
Short Call
The short call strategy is an options play for bearish investors, meaning they expect the price of the underlying asset (stock, Index, etc.) to decline. It involves selling (writing) a call option contract.
Seller of a call options has the obligation to buy in exchange of premium received in advanced.
This is different from directly selling the stock. Means you are essentially beeting that the stock price will decrease before the expiration date.
Pros:
Profiting From Choppy Market: When the movement of the underlying is very less, or approached a supply the premium of the call options will decrease, therefore buyer of the options lose money due to time value and volatility decrease. At this point options sellers (As Known As Options Writers) gain an advantage of eating options premium by selling them.
Unlimited Risk: Call option selling involves unlimited risk, if the underlying moves up faster then options premium will increase more faster than expected and traders may lose more money beyond their pre-determined risk.
More Margin Require: Selling a call option requies more margin that selling a Future contract of the same underlying.
Penalty For Margine Shortfall: In case of margin shortfall, sellers faces huge penaly.
When to sell a Call Options
As selling call options involves unlimited risk, therefore traders first focus on trend and volatility. While underlying trand is down and price at supply with less volatility, traders focus to make money from selling a call options. The technical scenario is important.
Traders Consider The Below Points Before Sell A Call Options:
- Underlying is in down trend
- Underlying approaching supply
- Underlying creating supply
- Broader market aslo in down trend and showing technical selling opportunity
- Implied volatility of the underlying is less
Strike Selection:
In case off selling call options, traders first indentify the stop loss of the underlying and sell the nearest strike price call options. For example, assume ABC Limited currently trading at 305.6, strike difference is 5, supply zone available at 306.8 - 313.6, traders will chose to sell 315CE.
Breakeven:
Breakeven = Strike Price + Premium Received
Maximum Profit:
Maximum profit is premium received
Maximul Loss:
Maximum loss is undefiend
Why Most People Lose Money In Call Selling
There are many reason why people lose money in call selling, most common reasons are..
- Selling call options at demand
- Seling call options in an up trend
- Selling call options in highly volatile market
- Bad timing
Protective Call Options
A protective call option strategy, also called a synthetic long put, is used to hedge a short position on a stock. It's essentially a way to limit your risk if the stock price goes up unexpectedly.
When you sell stocks and if the stocks move up, it will give you loss and at the same time the coll options you have purchased as an insurance of your short position, will give you profit.
In other way you can say Protective Call Option is a hedge of your equity or future short position
How it works:
You short the stock, meaning you borrow shares from your broker and sell them or you can sell a future contract of the underlying, hoping to buy them back later at a lower price to return to the broker.
You then buy a call option on the same stock. This call option gives you the right, but not the obligation, to buy the stock at a certain price (strike price) by a certain time (expiration date).
Why Do this?
You believe the stock price will go down (bearish), but you're worried at the same time and feel it might go up in the short term before falling.
The call option acts like insurance. If the stock price unexpectedly rises, you can exercise your call option and buy the stock at the strike price, which will likely be lower than the current market price. This limits your losses on the short position.
Things To Consider:
This strategy costs money upfront because you have to pay a premium to buy the call option.
There's a limited profit potential on the downside because your gains from shorting the stock are offset by the cost of the call option.
Example:
Assume you are bearish on ABC Limited it is currently trading at 550, you have identified that 560 is a good stop loss for selling. So you have sold out ABC Ltd at CMP 550, equvalent quantity of equity or you can sell future contract of the underlying.
Assume suddenly the stock price rise and reach 560, the stock or future contract will give you loss but the call option now become ITM in which you can find a Delta of 0.7 or more so if you lose 10 rupee for selling the stock or future you will earn around 7 rupee for buying the call options of the same underlying. Thus you can minimize your risk.