Long calls can be some of the riskiest options
trades you can make. If you're right about the timing and size
of a stock's move, buying calls can deliver big profits without even owning the stock. But if you're wrong about price, time, or
volatility, you can lose some or all of your investment really quickly. But not all long call strategies are equal. Some people swing for the fences every time,
making fast pie-in-the-sky bets with high risk and high potential returns. That can mean big wins when it works out,
but it's also a strategy that could bring LOTS of strikeouts and big losses. A different approach is more about pursuing
success through lots of singles and doubles over time trades that last for a few days
to a few weeks but may move at a more manageable pace. I'm Education Coach Cameron May, and I've
been teaching new traders about options for 15 years. I've seen a lot of the mistakes traders
make, so I'm gonna teach you about ways to avoid those mistakes. We'll talk through how long calls work and
discuss a smarter way to trade them that might offer lower profits per trade but
may increase the likelihood of success over time. I'll also show you how to set up and manage
this strategy on thinkorswim. For this video, we'll assume you have a
basic knowledge of options, the options greeks, and the thinkorswim platform, so if you're
an absolute beginner, check out our other videos on getting started with options. So, what is a long call? A long call is a bullish speculative trade
where you buy a call option on an underlying security you expect to move up, ideally in
a big way and quickly. Buying a standard call option contract gives
you the right to buy 100 shares of stock at the strike price on or before its expiration
day, though getting stock isn't the goal of this strategy. You expect the long call's value to increase
when the stock price goes up so you can sell back the contract for a profit before expiration. But, the move has to be big enough and quick
enough to make up for the effects of time decay, which erodes the contract's value. For example, let's say XYZ stock is currently
trading at $81 per share, and you think it'll go up in the next few days. You buy an at-the-money call contract with
an 81 strike price for a premium of $3 or a total of $300, with the expectation that
the premium will increase sufficiently over the next few days for you to sell the option
for a profit. But how much does the stock need to go up? And what if it doesn't? Let's take a look at the long call's risk
profile. The maximum gain for a long call strategy
is unlimited because the underlying stock could skyrocket, boosting the premium in the
process. And keep in mind, options profits aren't
linear. The higher the stocks goes, the faster your
potential profits can accumulate. This is one reason long calls are so appealing
to traders. The maximum loss is limited to the premium
you've paid. You could lose 100% of your investment in
the option if the underlying turns bearish or even just goes sideways. The break-even point for a long call at expiration
is the strike price plus the premium paid. However, we don't plan to hold this option
until expiration, so there are three forces that can determine the profitability of the
trade in the meantime: price, time, and volatility. These forces are measured by the options greeks. The first force is price and is measured by
delta. Long calls are delta positive, which means
call prices rise along with the stock price. This greek will give you a sense of how much
the options contract price may change with a $1 move in the price of the underlying. The next force is time. Theta measures the impact of time decay on
the long calls it's negative, so it works against our position. The closer you get to expiration, the harder
theta works against you. An expiration that's further away helps
alleviate some of that risk by reducing the rate of time decay. Our goal is to plan for a profitable exit
before theta melts away too much premium. The last force is volatility. Vega tells us how rising or falling implied
volatility could impact our options trade. Long calls have positive vega, so, ideally,
we'd like to see volatility rise. But remember, implied volatility often moves
OPPOSITE of the stock's price movement, so it's pretty common to see volatility
drop if the stock price moves up. So volatility is often another force working
against a long call. Now that we've covered how long calls work,
let's get into some common mistakes people make when trading them. The first is buying calls before a big event
like earnings in hopes of profiting from big moves. The problem is that the options can be expensive
at this time because of the high implied volatility. But as soon as the event occurs and the uncertainty
around price movement ends, all that extrinsic value disappears and the price of the options
collapse. This is called a volatility crush, and it
can be so dramatic that even if the stock moves in your direction, you can still lose
money. Take Tesla for example. I'm going to use a thinkorswim tool called
thinkBack to look at historical data. Here we are on Oct 21, 2020, the day Tesla
announced earnings after the closing bell. The closing stock price before the announcement
was 422.64. By the end of the next day, it was up just
over $3 at 425.79. With the leverage offered by long calls, you
might typically expect a profit as a result of a one day move of that size. But let's see what actually happened with
the options. On Oct 21, the Oct 30th at-the-money 422.50
call closed at $24. The next day, despite the rise in Tesla's
price, the same call closed at only 15.80, suffering about a 34% drop in value. Some of this drop can be attributed to time
decay, but the real culprit was the volatility. You can see why it's called a volatility
crush. The stock would've needed to rise an extra
$14 to overcome that crush. Up next is what I call the lottery ticket. By that I mean buying way out-of-the-money
strikes because they're cheap, and the potential return is huge These contracts are cheap for
a reason.. Far out-of-the-money contracts often expire
worthless because the probability of the stock moving enough to make them profitable is very
low. Let's look at an example in thinkorswim. I've got the December 11th call options
for Chipotle Mexican Grill, ticker CMG, pulled up. It's currently trading around 1323. Toward the bottom of the option chain is the
1410 strike, which is almost $90 out of the money. You could buy a contract for just $400 bucks
on the off chance it'll make a big move, but check out the bid/ask spread. It's $1.35 on a $4 contract. These way out-of-the-money options tend to
be thinly traded and poorly priced in a way that puts you at a disadvantage. From the moment the order is filled, you'd
be sitting on about a 20% unrealized loss. The stock would have to make a significant
move up just to overcome that obstacle. Plus, if you've based this lotto ticket
around an earnings event, the volatility crush could impact your losses too. Another common mistake is choosing an expiration
that's way too soon, like next week. Some investors do this because the options
are often cheaper, but if it doesn't make a big move quickly, time decay kicks into
high gear. The closer you get to expiration, the faster
time decay erodes your position. Let's take a look at an example of the impact
of time decay. A great tool to do this is called theoretical
price, or theo price, which I'll pull up. The theo price allows you to experiment with
changes in price, time and volatility. To begin our experiment, here's the 126
call on Apple expiring next week. The theo price begins with the current mid-price
of that option, which is currently 1.32. Now, using the theo price menu, I'll simulate
just one day passing and look at what happens to the simulated value of the option even
if the stock price stays the same. It fell around 10% over night. And as I mentioned, it'll only get worse
the closer you get to expiration. The last big mistake some traders make is
trading without an exit strategy. Before you ever enter the trade, it's important
to give yourself a point where you're ready to cut and run. On the upside, that point could be something
as simple as a specific price target of the underlying stock or a specific gain on the
option. On the downside, that could mean using stop
orders or exiting if you haven't hit your price target by a certain date. If you don't stick to your exit rules, you
could make gains and watch them slip away while hoping for more gains. Now that you know what not to do, let's
look at a smarter approach to trading long calls. It's a smarter approach because it's based
on more informed assumptions about how options work. It boils down to choosing at-the-money options
a few months from expiration on uptrending stocks that you believe are ready to pop. These factors are all meant to increase the
likelihood that the trade could be profitable. When you trade stocks, you only need to be
right about price to be successful. With options, especially long calls, you often
need to be right about price, time, and volatility. Make no mistake: Even with this smarter
approach we're talking about, it is still speculative and directional. If you're looking for something less speculative,
consider defined risk-return strategies like vertical spreads. So, how do you set up a long call? Let's go back to thinkorswim and get into
it. First up, you've gotta choose an underlying. This could be a stock or ETF. Consider highly liquid assets that are already
in an uptrend as opposed to looking for big event moves. Of course, there's no guarantee that upward
trend is going to continue, but it could increase your probability of success. . You could set up a watchlist of stocks to
keep an eye on. But for a long call, we need more than just
an uptrend we need significant upward movement in a short amount of time, typically five
to 15 days. That's where technical analysis can help. A chart pattern like a close above the high
of the low day could be a signal that a stock is bouncing off support and potentially ready
to make an upward move. This can serve as an entry signal for timing
the trade. So, here's a 1Y:1D chart of Disney, ticker
DIS. You can see we've got a 50-day simple moving
average added to it, which is uptrending. It also has an average daily volume well above
one million, so it's liquid. And here you can see the stock is trading
above its moving average trendline. If we zoom in we can see it recently bounced
off a previous price ceiling. And finally, it's in position to close above
a recent low day. To a technical trader, all of this may point
to a potential near-term jump. This will be our entry signal. Once you've chosen an underlying, you've
got to select a contract. In short, we're looking for highly liquid
options with plenty of time to expiration and without inflated implied volatility. The first part of that decision is choosing
your expiration. Even though you may only plan to be in the
trade for a few days to a few weeks, consider going much further out for your expiration think
50 to 100 days. For this example, that's the 19th of February
expiration, which is 80 days out. Remember, we don't plan on holding the option
all the way to expiration, we're just trying to take advantage of a projected price move
and get out. I've already mentioned that one of the common
mistakes is not buying enough time. You don't want to be right about the price
movement and still lose money because you didn't buy enough time. If you buy an option that expires in 90 days,
but the stock hits your price target in six days, you just get out and sell all that remaining
time. You might also want to make sure there aren't
any earnings or news announcements coming up that could impact the stock movement. Disney just had earnings, so we don't have
to worry about that. Next, let's take a look at the strikes. The in-the-money strikes are more expensive,
but you can see by looking at the delta they have a higher probability of expiring in the
money. The out-of-the-money options are less expensive,
but, like we discussed before, their probability is lower. So, you may want to consider something right
in the middle at the money moderate costs with moderate probability. And remember that we're looking for high
liquidity. A way to gauge that is looking for a low bid/ask
spread; one guideline options traders often use is that the difference between the bid
and the ask should be no more than 10% of the ask price. A tighter spread means you're more likely
to get your order filled at your desired price. For this example, we'll use the 150 strike. It's quoting me a buy price of 9.35, which
means I'd pay $935 per contract plus any commissions and fees to enter the trade. Now, we'll talk about risk management and
exit considerations in a minute, but one thing we can do right off the bat is to buy our
call with a stop order. This can help manage risk by automatically
triggering an order to close the position if the price of the option falls to a price
we set. You typically load up a buy order in thinkorswim
by just left-clicking the ask price, but to buy the contract with a stop, I'll right-click
the Ask price, point to Buy Custom, and select With Stop. It'll pull up some trade details at the
bottom of the screen. Let's walk through the order ticket. The first item is a green row, showing we're
buying. Below it is the red stop order. Our next step is to figure out just how many
contracts we want to buy. Position sizing is one of the main ways you
can manage your risk, which is crucial to trading long calls. Like I said before, even the higher-probability
approach we're discussing here is still very speculative. And even though the risk is limited to the
amount paid in premium, if you allocate too much going after big returns, you can easily
blow up your account. To determine how many contracts to buy, you
need to know two things: your portfolio risk and your trade risk. Portfolio risk is the total amount of your
portfolio you're willing to lose on a given trade. Consider setting aside no more than 1% of
your active trading portfolio per trade. Some traders put as little as half a percent. So, for simplicity, let's say I'm trading
with a $100,000 portfolio. If I'm willing to lose no more than 1%,
my portfolio risk would be $1,000 per trade. Next is trade risk, which is the amount you
could lose in a given trade. For a long call, the trade risk is the premium
you pay to buy the contract plus any commissions and fees. Even though we're using a stop order, there's
no guarantee it'll fill, so we'll use the full premium. For our example, the trade risk is $935 per
contract plus the contract fee. Now that we know our portfolio risk and trade
risk, we can figure out how many contracts to buy. To do this, take your portfolio risk and divide
it by your trade risk. So, our portfolio risk of a thousand divided
by the premium of $935 equals 1 contract. Once you get more familiar with trading long
calls, you can start factoring your stop order into your trade risk, but to start out, you'll
want your position size based on the full premium. Let's finish entering the sell-stop order. A common stop management technique is to place
the sell order at about 50% of the purchase price of the option. For our trade that would be about 4.70. So, I'll just update the price with that. Also, we want to make sure the stop order
stays in force for the duration of our trade. So, I'll open the Time In Force menu, and
select GTC Good Til Cancelled. Before we actually send the trade, let's
think about how we might get out of it. Options trades can move really quickly, so
you'll want to set some firm exit rules. You already established one exit rule by setting
a stop order at 50% of the options purchase price. This rule is pure risk management, as it may
help prevent your trade from losing all of its value. If your stop is hit, chalk it up as a loss
and move on to the next trade. But just as important as managing losses is
managing profits. If the trade is going your way, you might
be tempted to just let it ride and rack up the returns. But with options, things can change fast,
and potential profits can evaporate in the blink of an eye. To keep greed in check, consider setting a
firm profit target. This could be a price target on the underlying
stock, a specific dollar amount gained, or a specific percentage gained on the option. For example, let's look at how a trader
might pick a price target on Disney. In recent weeks, on two separate occasions,
the stock moved up about $12 as momentum shifted from bearish to bullish. With today's bounce off an apparent floor
at 147, a trader might anticipate a price target of about 159. Just keep in mind that past performance is
not a guarantee of future performance. It can be tough to stick to a target and walk
away from potential profits, especially when things are going well. But, even if it sometimes means leaving money
on the table, having consistent exit rules can help protect you from losses over time. Of course, there will be times when a trade
doesn't go your way. There's always your stop order, but what
if the trade doesn't move against you enough to trigger the stop, or it goes up but not
quickly enough? How long should you wait around for the underlying
stock to go where you want it to? The last exit rule to consider is exiting
if the stock price hasn't moved at least half as much as you expected in half the time
you anticipated. For the type of strategy we're discussing,
a common time frame could by anywhere from a few days to a couple weeks. For Disney, the previous moves have happened
within a week. So we'll say that if the stock hasn't
reached 153 in the first few days, it may be time to think about getting out of it. If this happens, it means you haven't timed
the option properly and time is of the essence. You'll also want to think about bailing
if the underlying closes below technical support levels. This is what's known as a counter-indicator,
and it may suggest the trend is reversing. Closing the trade at this point could save
some capital. Ok, now that you have some considerations
for when to get out of the trade, let's go back to the Trade tab and place our order. Let's make sure everything looks right and
then hit Confirm and Send. Our maximum gain is unlimited, like we talked
about before. Our maximum loss shows here as the full premium,
which is possible, but remember, we've set a stop order at 50% of the options premium,
which could help reduce our losses. If the stop is triggered, it'll send a market
order and compete with other market orders at that time, so there's no guarantee it'll
fill at the 50% price. Also note the transaction fee. If we're ok with this, let's go ahead
and hit Send. And there we go. We've just bought a long call. Now let's take a moment to break down how
different factors like stock price, time, and volatility could impact this trade. I'll open up the risk profile in the Analyze
tab to play around with the numbers. First, I'll select the position. Now we can see from the risk profile that
our max gain is unlimited, our max loss is limited to the premium we paid (though that
doesn't account for our stop order), and our break-even point is about 159.35 at expiration,
but remember we're planning to exit long before expiration. The factor that will affect us the most is
the stock price, so let's see what happens when price changes using the price slice feature. I'll set some price slices to show the stock
rising or falling $10. The stock is currently trading at 150.54. If the stock price goes up by $10, you can
see a hypothetical gain of about $630. Of course, if the stock price goes down by
$10, we could lose about $445. But how does time factor into the profit or
loss of this trade? Let's move the date forward a week and assume
the price of the underlying stays the same. We've got a potential loss of more than
$32 in one week thanks to time decay. But what about vega? If implied volatility rises, our options value
could go up, and if implied volatility falls, our options value could go down. Let's take a look at a fairly big change
in implied volatility, just to illustrate the point. First I'll reset our date. Then I can click the gear icon to reveal the
implied volatility adjustment. I'm going to give us a little more space
here. Now, if I increase implied volatility by 5%,
we'll see the projected unrealized gain of around $155; if we move it down by 5%,
we can see a projected loss of about $125. Remember, placing a trade is just the beginning. This is an active strategy, so you'll want
to monitor closely with your exit rules in mind. To show you how to do this, let's head back
to the Monitor tab and look at a long call I've already got on our demonstration account. I'm going to look at some calls we bought
on Starbucks. If we click on quantity, we can see on the
24th we bought 4 of the February 19th 97.50 calls for 5.30 each. We do have a small profit right now, but lets
revisit the technical logic of the trade. I'll pull up the chart of Starbucks. You can see we had an upward trending moving
average, price was trading above the moving average, and we had closed above a recent
low day. We can also see that on the two previous bounces
the stock had sizeable upswings in the following week. On the 24th, we were anticipating the stock
would move a similar distance in a similar timeframe, giving us a target around 106. Unfortunately, Starbucks has only drifted
sideways, and is only slightly above that entry price. One of the potential exit rules we discussed
earlier was exiting if the stock has not moved half the distance in half the time frame. And here we can see that over the course of
4 days, the stock has only moved about a dollar. This could mean our timing was off on this
trade, and it's time to pull the plug. And again, it may be tempting to try to justify
staying in since it's slightly profitable, but a key to success with long calls is to
follow your rules consistently. So I'm going to show you how to close out
of this position. To do that, I'll right click on the position
and click Create Closing Order. So you can see on the order ticket we're
selling our 4 contracts at 5.55 each. I'm using a limit order and leaving the
time in force as day. I'll click Confirm and Send, but keep in
mind that the max profit and loss don't apply to a closing order. Also note the transaction fee. Everything looks good, so we'll send the
order. Remember that we used a limit order, so there's
no guarantee it will fill. And that's a smarter way to trade long calls. Remember, even though the approach we discussed
may be higher probability and less risky than others you'll see out there, it's still
risky. Make sure you practice paper trading to get
a feel for how these trades can move. To download thinkorwim®, check out the links
in the description below. We have lots more education. Subscribe to our channel and hit that bell
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