Long Call vs. Long Call Spread: Which Should You Play?

How to determine whether you should use a long call or a long call spread

Sep 25, 2015 at 1:51 PM
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    There are many ways you can use options to bet bullishly on a stock, but buying a long call might be the most popular. This straightforward strategy lets you profit from an equity's expected rise, and for only a fraction of the cost of investing in the underlying shares directly. On the other hand, we have the long call spread (a.k.a. the bull call spread), which combines a long call with a short call at a higher strike.

    So which strategy should you choose for your bullish trades? Let's take a closer look at the pros and cons of each approach.

    The Long Call

    Buying to open a call option affords you the right (but not the obligation) to purchase 100 shares of the underlying stock at the strike price, should the shares rise above that strike prior to expiration. However, it's more common for call buyers to "trade for premium" -- which means they are looking to profit solely from changes in the option's value. If the option's premium increases sufficiently prior to expiration, most call buyers will sell to close, thereby locking in their gains and exiting the trade.

    A long call position carries limited risk. The initial premium you pay to buy the option is your maximum potential loss (along with any brokerage fees and commissions, of course). This 100% loss will be realized if the stock closes at or below the call's strike price upon expiration.

    However; should the stock rise, the holder of a long call option is able to enjoy theoretically unlimited gains. That's because there's no limit to how high the underlying stock can rally.

    The Long Call Spread

    In this type of debit spread, a long call position is combined with a sold-to-open (short) call option at a higher strike price. Generally speaking, the strike price of the sold call corresponds with the trader's expected upside target for the shares during the life span of the trade.

    The motivation behind the sale of the additional call option is to reduce the cost of entry on the trade. This lower upfront cost has a ripple effect -- not only is the maximum potential loss reduced, but so is the breakeven point on the trade.

    That said, the trader who opts for a long call spread sacrifices the unlimited profit potential of a solo long call. No matter how high the underlying stock should rise, the most the spread player stands to gain is limited to the difference between the bought and sold call strikes, less the initial net debit. If the stock embarks on a major rally above the sold strike, there's going to be an opportunity loss involved in choosing the spread over the lone call.

    Long Call vs. Long Call Spread

    Ultimately, the choice between a long call and long call spread will depend upon your forecast for the stock. If you expect a sharp and sustained move higher, it makes sense to swallow the increased cost of entry on a long call in order to take advantage of the uncapped profit potential.

    If you expect the stock's gains to fizzle out at a specific price point, though -- a previous resistance level, perhaps -- you might opt for the long call spread. This strategy will allow you to profit from the stock's advance while minimizing your dollars at risk.



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