Understanding Long Call, Short Call & Protective Call Options Strategies

Dive deep into the world of options trading with our in-depth guide. Learn the mechanics, risks, and rewards of Long Call, Short Call, and Protective Call options strategies. Gain valuable insights and practical tips to make informed trading decisions.

Long Call

Short Call

Protective Call options

Long Call options:

Long call options is a bullish approach in option trading, when the buyers believe that the underlying will go up faster they buy call options, it is called long call options trading. Note my one word "Faster" it is necessary for long call.

Buyers of call options have the right, but not the obligation, to exercise the option to buy the underlying stock at a specific price (strike price) by a certain time (expiry date).

More elaborately, The right to exercise means you can inform the exchange that you want to buy the underlying stock at the strike price, even if the option expires out-of-the-money (OTM). However, taking delivery is not mandatory.

Taking delivery or exercising the option contract which is OTM is actually committing loss in your account. What price you will receive the delivery? It is the strike price.

Assume ABC Ltd was trading at 500 and that time you have purchased 500CE and pay a premium of 10/-, on the day of expiry ABC Ltd expire at 490/- so your option premium will become zero. Now if you thought that, in future, ABC Ltd will move up and you don't want to lose the premium you have paid, simply inform the exchange and paid 500/-*lot size (paying @ strike price), exchange will give you payout of the security. Where you could buy the underlying from open market at the rate of 490/-, you are paying the exchange 500/-. It is your money, if you wish to lose, it's up to you, you can, anytime.

The risk for buyers of call options is limited, while the potential reward is unlimited.

Positive Side of buying only call options:

Limited risk: If you buy only call options, then your risk is limited, you can hardly lose the amount you have paid as a premium. Assume you have purchased 500CE of ABC Ltd and paid a premium of 10/- the lot size is 1000.

The net premium you have paid =10*1000

=10000.00

If the ABC Ltd close anywhere below 500, you will lose the entire premium. No matter where it is closing 498 or 298. If you would purchase ABC Ltd future or stocks and it would come down 298 till the expiry, your loss would be huge. But in call options buying you can limit your loss.

Leverage: Traders with strong technical analysis skills can leverage options to potentially achieve higher returns compared to other investments. Need to remember that leverage kills unskilled traders.

Negative side of buying a call options:

Time value decay: The value of call options decreases over the time if the underlying follow your direction faster of the implied volatility is less than the normal. Specially ATM (At-The-Money) and OTM call options. Holding long call options overnights create unnecessary risk in less volatile market.

When to buy a call options:

Timing is the most important part in case of only call options buying. Technically proper buying opportunity is necessary for successful call options buying.

Mostly professionals buy call options after the below scenario.

Price approached a higher timeframe demand zone and RSI positive divergence occurs in lower timeframe chart.
Price is giving a proper trendline breakout.
Price is creating a Piercing pattern.
Price is creating long CMO pattern.
Price is creating any perfect technical buying opportunity after a perfect demand.

There are many other types of entry also available which performed by the professionals.

Maximum profit: Maximum profit could be unlimited if the underlying rise unlimited.

Maximum loss: Maximum loss is only the premium you have paid during the buying, even if the underlying fall unlimited.

When you are trading options you must calculate your Breakeven Price first, during the breakevent point calculation always calculate on expiry basis. Let us learn how to calculate breakeven point for long call options.

Assume an underlying ABC Ltd has formed any buying scenario stated above. The ABC Ltd trading at 1200/-

You have purchased a 1180CE and paid a premium of 52/-

Now lets understand the Intrinsic value and time value first.

Intrinsic value of 11800CE = 1200 - 1180

= 20

Time value of 11800CE = 52 -20

= 32

Now, on the expiry day you want back your own investment only (here 52/-), we know on expiry, options premiums are equals to its Intrinsic value. That mean currently 1180CE should have an intrinsic value of 52/-. Already we have learnt to calculate the intrinsic value of a call options.
Intrinsic Value of A Call Options =Current Market Price - Premium Paid, he IV=52/,let us assume current market Price =Xwhich is the Breakeven Point here, so we can say
52=X-1180
X=1180+52
Breakeven Point = Strike Price + Premium Paid
That mean if the ABC Ltd Close at 1232 then, neither we will be in profit nor in loss.

Maximum loss = 52 if the underlying close at or below 1180

Maximum profit = Closing Price of ABC Ltd on expiry - 52

If you exit before the expiry then calculation will be different, you should calculate the probable gain loss using Black & Schole Options calculation model.

Please note buying only options are too risky, if you don't have proper market and technical knowledge you may lose your entire wealth in shorter-term.

Short Call Options:

Short call options is a bearish approach in options trading when the market has less volatility but technically there are symptoms that the underlying may fall but not sharp fall, traders want to gain an advantage of time value erosion by selling a call options is called Short call options trading strategy.

Writers of the call options have the obligations of assignment in exchange of receiving payment in advance (When you sell an options, you receive the premium in your account).

When you sell a call options, you are bearish in the market, if the underlying fall and close below the strike price, then, on expiry day the options premium will become zero and you will keep the premium you have received.

By any chance if the underlying expire above the strike price then manually you have to buy back the call options you had shorted or you can give a payout of the security to the exchange (You will able to give the payout of the underlying security only if you are holding equivalent quantity of shares of underlying, if you don't have those numbers of shares in your demat account then square off is mandatory or else you have to pay a huge a penalty).

Writers of the call options risk is unlimited where reward is limited.

Therefore the margin for writing a call options is much more higher than buying a call options.

When to sell a call options:

Experience, Market & technical knowledge are the key points of options writers, before you write a call options acquiring of proper market and technical knowledge are important. Because the ideal situation to sell a call is, when market is in week down trend and implied volatility is less than the normal and approaching any supply zone or creating supply, or any technical selling scenario occurs in chart pattern, professional take the advantage of time value erosion.

Following the below technical situations can be good scenario for a call options writing after identifying downtrend with less implied volatility.

Price approaching a higher timeframe supply zone.
Price is giving a proper trendline breakdown.
Price creates a dark cloud cover pattern.
Price creates a Short CMO pattern.
Price creates Shooting Star pattern.

There are many other patterns also available which professional traders uses.

Maximum loss: Unlimited. As the premium of a call options is directly proportionate, therefore the premium of a call options may rise unlimited if the stocks rises unlimited before the expiry. So maximum loss could me unlimited. Remember, options sellers may lose more than their wealth (Not only the investment capital) if their views gone wrong.

This is the riskiest trade ever you can identify in stock market trading.

Maximum profit: The net premium received. If the underlying fall drastically, still the buyer of the options won't pay you further money for your excellent view.

Breakeven Point: Strike Price of the sold Options + Premium received.

Example: Assume ABC Ltd trading at 1200 and you have shorted 1220CE and received a premium of 15/-.

Maximum Profit= You can earn maximum 15/- if the underlying expire below 1220.

Maximum Loss= It can be unlimited if the underlying rises unlimited.

Breakeven Point= 1220 + 15

= 1235

In other hand you can say, you are safe until 1235, but if volatility increase suddenly then most of the traders lose control on their patience and make huge losses. Unless you are a poised professional and you have depth market and technical knowledge, you should stay away from call options selling.

Protective Call Options Trading Strategy:

A protective call options is also known as synthetic long put options, it used to hedge on a short position of a stock. It essentially limits your risk if the stock price rises unexpectedly.

When you sell stocks and if the stocks move up, it will give you loss and at the same time the call 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.

protective-call-options-trading-strategy

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.

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, equivalent 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.

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