Long Call vs. Call Spread | Options Strategy Comparison

welcome to project option everybody my name is Chris and in this video we're going to talk about long call options versus long call spreads so we're going to compare the two strategies and discuss the notable differences between buying call options and buying call spreads and we're going to do that by using real examples with options on Facebook now during those examples we're going to talk about the pros and cons of long calls and long call spreads and finally we're going to talk about when to buy call options and when to buy call spreads based on the things that we talked about in the video now the first topic we're going to cover when comparing these two strategies is the risk and reward so let's compare the risk reward potential when buying call options versus buying call spreads now long calls have limited loss potential and virtually unlimited profit potential and when you look at the risk profile graph of a long call option the expiration payoff diagram will look something like this image that we're looking at right now so on the bottom we have the changes in the stock price and on the y axis or the vertical axis we have the profitability of that strategy so if the stock price is anywhere below the called strike price at expiration the strategy will lose the maximum amount but if the stock price increases there's no limit to the profitability of a long call strategy now most aggressive directional traders love the long call strategy because of its limited loss potential and unlimited reward potential in nature so now we're going to hop over to the long call spread and we're going to look at the expiration payoff diagram for the long call spread strategy and we're going to look at any differences compared to the long call strategy now similar to the long call option a long call spread has limited loss potential however the profit potential is limited now when you look at the expiration PNL diagram for a long call spread you're going to see something with the following shape now just like the long call position at any price below the long call strike price at expiration the long call spread will expire worthless and therefore the maximum loss potential will be realized now at any price above the short call strike price we can see that the long call spread will realize the maximum profit potential but unfortunately the profit potential is going to be the same E the stock price is a hundred or a million dollars above that short called strike price so unlike that long call position a long cost brand has limited profit potential which is realized if the stock price is above the short calls a strike price at expiration now be sure to keep watching because in just a second we're gonna go over some real-time examples of long calls and long call spreads using options on facebook now at this point you might be wondering if both long calls and long call spreads have limited lost potential but long call spreads have limited profit potential why would anybody buy a call spread now we're gonna go over this in depth in just a moment with some real examples but the short answer is that the premium collected from selling a call option against a long call option lowers the net premium paid which reduces your overall loss potential so if you look at buying a call and compare that strategy to selling a call against that call since the premium paid is going to be lower for the call spread the overall amount that you can lose on the position will be less when you look at that call spread compared to just buying that call and the second reason which kind of adds on to that first point there is that the lower premium paid also reduces the break-even price of your position which means the stock price does not have to increase as much for the strategy to break-even so when you buy a call option compared to buying a call spread the call option by itself is going to have a higher breakeven price then that call spread which means you need the stock price to increase by a more significant amount for your strategy to break-even at expiration so it's a lower probability trade to buy a call option as compared to buying a call spread all right so now that we've talked about the basic differences between buying call options and buying call spreads let's go ahead and look at some real time examples of both strategies and compare their risk reward potential directional exposure time decay exposure and exposure to changes in implied volatility alright so now that we've talked about the basic differences between the long call and long call spread strategies let's go ahead and look at a real time example of each strategy to talk about more specific topics related to each of them so we're going to use Facebook for our examples today so Facebook as of is trading at 178 dollars and 72 cents per share so let's go ahead and look at some long call and long call spread examples in facebook so for this example we're gonna go to the expiration cycle with 67 days to go and that's going to be the January 2018 expiration cycle so for this example we're going to use the at-the-money long call and then we're also going to use that same strike and sell another call against it to create our call spread so the closest strike price to the current Facebook stock price is going to be the strike price of 180 dollars so to buy that call option we're gonna click on the asking price of $6.20 and we're gonna lock that in now to create our call spread we need to sell a call against this 180 call so we're gonna buy that 180 call again and then we're gonna sell in this case the 190 call so as we can see here we have our single long call option which is just buying the 180 call for six dollars and 20 cents and we can see our call spread which is buying the 180 call and selling the 190 call against it for a net debit of three dollars and sixty nine cents so now that we have both of our trades queued up let's go over to the risk profile analysis and look at the risk and reward potential of each strategy alright so now I'm at the risk profile page and I'm looking at only this long call option which is buying the 180 call that expires in January of 2018 on Facebook so as you can see here the entry price is $6.20 so let's start with a maximum loss potential now when you buy a call option the maximum amount that you can lose is the premium that you pay times 100 dollars times the number of contracts so in this case we're only buying one contract and since we're paying $6.20 our maximum loss potential is going to be $6.20 times 100 dollars and that's because the standard equity option contract multiplier is 100 dollars so 6 dollars and 27 cents times 100 is six hundred and twenty dollars so as we can see here on the lower left-hand part of this chart it says minus 620 now that is the X pl of this strategy based on the stock price that I'm hovering over so as we can see here at any price below one hundred and eighty dollars the loss at expiration will be six hundred and twenty dollars and that's because that one eighty call will expire worthless and since we paid six dollars and twenty cents for it we'll lose six dollars and 20 cents per contract which in actual PNL terms is a loss of six hundred and twenty dollars now in terms of profit potential there is no limit to how much we can make on this trade because if Facebook you know blasts off and shoots to the moon our call contract will rise in value with the increase in that stock price now of course it's not very likely for Facebook to you know reach the prices that I'm looking at now but it is one of the benefits of using a long call option to trade a very very bullish assumption so if you're aggressively bullish on Facebook and you think it's going to increase in price by a substantial amount then the long call strategy is very beneficial to use because you have limited loss potential if you're wrong but if you're right and Facebook explodes then you have all of this profit potential to make so now let's go ahead and look at the call spread portion and really the cost spread is just the same position so it's the long one ad call except we're selling another call at a higher strike price against it so let's go ahead and queue that up so as we can see here we have a very different risk profile than we did with the long call option and that's because the call spread has limited profit potential since we're selling a call against that long call now one of the benefits of the call spread is that compared to just buying that call option we have less loss potential so as you can see here just buying the call option will cost us six dollars and 20 cents per call contract but if we instead purchase the 180-190 call spread our net debit is only three dollars and sixty nine cents so similar to a call option the most you can lose when you buy a call spread is the premium you pay times one hundred dollars so in this case three dollars and sixty nine cents times 100 is three hundred and sixty nine dollars if we look at the risk profile we can see that the loss at expiration if Facebook is below 180 is going to be three hundred and sixty nine dollars per call spread so if Facebook shoots up and is above 190 at expiration then our maximum profit potential is going to be six hundred and thirty one dollars but as we can see if Facebook goes all the way to you know three hundred dollars our profit potential is still going to be six hundred and thirty one dollars and if Facebook is at one hundred and ninety one dollars our profit potential is still going to be six hundred and thirty one dollars so really when you're comparing a long call to a long call spread the benefit of the long call option is that you have unlimited profit potential if the stock price increases however you do have more risk compared to buying that call option and then selling a call against it to create a call spread so in this example our long call can lose six hundred and twenty dollars per contract and has unlimited profit potential but our call spread can only lose three hundred and sixty nine dollars but at the same time it only has six hundred and thirty one dollars of profit potential now I didn't mention it but the profit potential can be calculated by taking the width of the call spread and subtracting the debit from it so in this case we're selling the 190 call and buying the 180 call which means our call spread width is $10 so 190 minus 180 is $10 and if we subtract 369 from that we get six dollars and thirty one cents if we multiply that by 100 we get six hundred and thirty one dollars of profit potential per call spread that we purchase so while we have limited profit potential our loss potential is much lower compared to just buying this call option now the next thing we need to talk about is the break-even price of a long call versus the break-even price of a long call spread now in both cases you can calculate the break-even price by taking the long call strike price which in our case is a hundred and eighty dollars in adding the net premium page for the strategy so we're going to start with the long call by itself so the strike price again is one hundred and eighty dollars and to buy the one eighty call expiring January of 2018 we're paying $6.20 so that means our breakeven is 180 plus 620 which is 180 $6.20 now as we can see here right at 180 620 our breakeven is going to be you know our piano is going to be zero so if Facebook is right at 180 $6.20 at expiration in January of 2018 this 180 call is going to be worth 6 dollars and 20 cents which is exactly what we paid for it and therefore we won't make or lose any money on the trade now as we can see here since we're paying less money for this 180-190 call spread our breakeven is going to be lower so if we switch over to the call spread we can see that the break-even price is going to be 180 369 so we're taking the long call strike price of 180 and we're adding the debt the debit paid of three dollars and sixty nine cents so 183 69 so as we can see here if we buy this call spread our breakeven price is lower which means we don't need Facebook to increase as much for us to not make or lose any money on the trade so when you're buying a call option you need the stock price to increase more significantly just to get back all of your money on the trade or not lose any money compared to buying a call option and selling a call against it now the reasoning for that is when you buy a call spread your debit paid is going to be less than if you just bought the call and didn't sell anything against it so one of the benefits and you know one of the most attractive parts of buying call spreads instead of just the call is that your breakeven price will be lower which means there's a higher probability that you do not lose money on the trade all right so the next topic we're going to talk about is the Delta exposure of the long call and long call spread strategies so when we talk about Delta exposure we're talking about how much we're expecting to gain or lose if the stock price changes by one dollar now the Delta will change as the stock price changes dramatically so for this example we're just going to use plus or minus one dollar as the expectation for how much we're going to make or lose so right now I only have the long 180 call selected so as you can see here the Delta of the 180 call is positive 50 and that means if the stock price increases by $1 we're expected to make $50 on the trade and if Facebook decreases by $1 we're expected to lose $50 on this trade now of course that assumes that the movement happens today without any changes in time or implied volatility or any of the other inputs so this is just direction now when we look at the call spread we can see that the Delta is plus 23 so that's that's more than or less than half of the Delta exposure of just owning this 180 call by itself so that plus 23 Delta means that if Facebook increases by $1 we're expected to make $23 on the call spread and a Facebook falls by $1 we're expected to lose $23 on that call spread now as you might guess that means that the long call is more aggressive in terms of the directional outlook and that's because it's Delta is higher so when you just own this call the Delta as of now is plus 50 and if you instead buy the call spread the Delta will be plus 23 so in terms of direction it's very clear that buying a call option is a much more aggressive strategy and that stems from the fact that a long call option will have a higher Delta value than buying a call spread now another thing we're going to talk about is the change of that directional exposure so as we can see here this pink line actually gets more and more sloppy as the stock price increases so the slope increases so that means that if facebook increases our Delta exposure is expected to be higher than it is now so right now the Delta is plus 50 and if Facebook increases by $10 we can see that the Delta exposure is expected to be plus 72 so that means if Facebook increases by 10 dollars and then increases by another dollar we're expected to make $72 from that additional $1 increase but we're expected to lose 72 dollars if it falls from that price so in short if you just own a call option you directional exposure is going to get closer and closer to plus 100 which just means your position is going to get closer and closer to owning a hundred shares of stock as the stock price increases now as you can see here it gets closer and closer to zero as the stock price decreases and that just means that the further and further out of the money your option gets the closer your position is going to be to owning zero shares of stock now if we go ahead and look at the long call spread we can see that the Delta actually starts to taper off as the stock price increases so as of right now with the stock price right around you know its current price our Delta is plus 23 but as we can see here if the stock price increases to let's say 210 dollars then our Delta exposure is expected to only be +7 so that means if the stock price were to jump to $210 today then our Delta exposure for this call spread would expect it to be only plus 7 so that means if the stock price increased by another dollar we would only be expected to make $7 and if the stock price fell by $1 we would only lose $7 so that's one difference between long calls and long call spreads is that as the stock price increases a long call position will get more and more bullish because the Delta will approach plus 100 and in terms of the call spread the further the stock price increases the closer and closer your call spreads Delta will get to zero so that's one huge difference in terms of directionality when comparing calls and long call spreads now the next thing we're going to talk about is time decay as it relates to owning call options and owning call spreads now time decay or theta decay refers to the profit or loss exposure from the passage of time as the extrinsic value in an option position decreases as those options approach expiration so in the case of this long call option the long one-eighty call expiring in January of 2018 we know that if facebook is below 180 then this 180 call option is going to expire worthless so right now it's worth $6.20 and all of that value is extrinsic value now when an option expires it has no more extrinsic value remaining as all of its value will be intrinsic value now that means that if Facebook remains rated its current price which is below 180 dollars we know this six dollar and twenty cent option will approach zero dollars as time passes so time decay refers to how much this option is losing on a daily basis as its extrinsic value approaches zero so let's go ahead and look at the theta or time decay exposure of this long call option that's expiring in sixty seven days in January of 2018 so as we can see here with the stock price at the current price our theta exposure is minus five now that means that with each passing day we're expected to lose $5 on this long call position and that just means that you know as this extrinsic value of this option is decreasing with every passing day we're going to lose money because the option price will be decreasing so if we just buy this 180 call our theta exposure is minus five which means we're expected to lose five dollars with each passing day now if we switch over to the call spread let's go ahead and look at the theta decay exposure of that call spread so right away we can see that the theta decay or time decay exposure of this 180-190 call spread is only minus 114 now that means with each passing day we're only expected to lose one dollar and fourteen cents on the position which is much lower than the minus five theta that we are we're experiencing on that long windy call so when you compare the time decay exposure of a call to a call spread the long call by itself is going to have more exposure or more loss potential from the passage of time relative to that call spread now that's because not only do we own this 180 call but we also sold a 190 call against it now as time passes both of these call options are going to lose value since they are both out of the money so at expiration if Facebook is below 180 this long 180 call is going to expire worthless and this 190 call will also expire worthless so the benefit of the call spread is that since we shorted this 190 call the profits from that call expiring worthless will offset the losses from owning this 180 call so as time passes both of these options will decrease in value except with the call spread since we shorted this 190 call the decrease of this 190 call overtime is going to actually generate profits for us which will offset the losses from the time decay of this long 180 call and that's how we get that minus 114 theta so when you compare a long call to a long call spread the call spread will have less exposure to time decay because you have a short option that is decaying in favor of your portfolio which is going to offset the losses from the time decay of that long option alright so the last topic we need to talk about is each strategies exposure to changes in implied volatility now a change in implied volatility simply refers to an increase or decrease in the amount of extrinsic value that exists in a stocks options so for example if you had a $100 stock with 20% implied volatility and a different $100 stock with 30% implied volatility the 100 the $100 stock with 30% implied volatility would have more expensive options and therefore more extrinsic value in those options compared to the $100 stock with 20% implied volatility so when we're talking about changes in implied volatility we're basically talking about overall changes in the prices of options on that stock so when you own a call option you have positive Vega exposure which means you have a positive exposure to change as an implied volatility so in other words if implied volatility increases you are expected to make money from that increase in implied volatility or extrinsic value which makes sense because if you own an option outright you want its price to increase as much as possible now if that price increase comes as a result of an increase in implied volatility which just means that people are buying up those off they are becoming more expensive and have more extrinsic value then that means your call option is going to increase in value which is going to yield profits for you so on this risk profile graph we're looking at two implied volatility environments the first one is a twenty point three eight percent implied volatility which is simply Facebook's current implied volatility reading and the second line we're looking at is thirty point three eight percent implied volatility which is just a ten percent increase from Facebook's current implied volatility now when we look at these P&L readings you can see that the higher implied volatility is going to give us more profits comparatively lower implied volatility reading and that's just because it is showing us Facebook's are showing us that options price with that added extrinsic value so at 30 percent implied volatility the options on Facebook will have more extrinsic value than they will if Facebook had its current applied volatility of twenty percent so if we had an increase in Facebook stock price with an increase in implied volatility we can see that the PNL expectation is going to be higher with the increase in implied volatility relative to that same stock price change with no change in implied volatility now on the other hand if implied volatility decreases and well if I'm tied volatility increases as Facebook decreases as we're looking at right now then the increase in implied volatility will offset the losses from that adverse directional movement in the stock price so for example if Facebook fell to one hundred and seventy dollars if implied volatilities did not change and remained at twenty point three seven percent then our loss would be expected to be around a loss of three hundred and fifty three dollars and if implied volatility were to increase by ten percentage points with that same decrease in the stock price then our P&L is expected to only be negative eighty seven as opposed to negative three fifty three so when you buy a call option by itself an increase in implied volatility is going to help you in terms of profits when the stock price increases and is going to offset your losses if the stock price decreases so now let's do the same analysis with the long 180-190 call spread in January of 2018 on Facebook so let's click over to the call spread and look at this risk profile with these two different implied volatility readings now as you can initially just observe from this chart the two lines actually have a crossing point as opposed to you know when we're just looking at this long call option the higher implied volatility line is higher than that lower implied volatility line at basically every single price now we're looking at the call spread we can see that the higher implied volatility line is higher than that lower implied volatility line when the stock price decreases but when the stock price increases that lower implied volatility line is actually more profitable than that higher implied volatility line so what does that really mean well that means if we buy a call spread and the stock price decreases an increase in implied volatility is actually going to be beneficial for our position because that increase in implied volatility is going to offset some of the directional losses that we're going to experience from this positive Delta strategy of buying a call spread now on the other hand if the stock price increases then an increase in implied volatility is actually going to be harmful to our position so when you buy a call spread you want the stock price to increase and you want implied volatility to either remain the same or decrease from its current value because when you buy a call spread you can only realize your maximum profit potential if all extrinsic value in the options goes away now that basically means that if you buy a call spread in an ideal scenario you'd have the stock price increase to a price above your short call strike price and in this case that's going to be $190 and you're going to want implied volatility to decrease because if the stock price is above your call spread and your call spread is fully in the money then you want all of the extrinsic value of those options to come out of the position as that will allow you to achieve maximum profit potential so just to verify that for you I'm gonna take the current implied volatility and we're gonna look at the P&L X back tation of this position if implied volatility went to zero now if implied volatility goes to 0 that means Facebook's options have absolutely no extrinsic value remaining so I'm going to go up here and I'm going to do negative twenty three point three five percent and as we can see we're looking at basically the expiration payoff graph of this call spread so if Facebook were to go to $190 and implied volatility went to essentially zero then our profit would be right around six hundred and thirty dollars which is the maximum profit potential of this call spread now more specifically the maximum profit potential of this call spread is six hundred and thirty one dollars but this chart says six hundred and twenty nine because I only subtracted twenty twenty 0.35% from twenty point three eight percent so it's not exactly zero now we've just covered a ton of content so to quickly summarize long calls are more aggressive directionally and have more risk compared to long call spreads that use the same long option and to follow that up long calls have more exposure to losses from time decay compared to long call spreads as the decay of the short option and the spread offsets losses from the decay of the long option now in regards to exposure to implied volatility long calls benefit from increases in implied volatility no matter what happens with the stock price now on the other hand long call spreads benefit from increases in implied volatility when the stock price decreases and as the stock price increases long call spreads actually benefit more and more from decreases in implied volatility so if that stock price is moving through your call spread strikes a decrease in implied volatility will actually help your position profit more and more so now that you have a firm understanding of buying a call option versus buying a call spread when should you buy a call and when should you buy a call spread since you've learned that a long call by itself is much more aggressive in a directional sense compared to buying a call spread then a long call position is suitable when you are extremely optimistic about the stock price in the future so if you're expecting a significant increase in the stock price in the future then buying a call option has more profit potential for you than buying a call spread now when it comes to call spreads call spreads are great to use when you're not as bullish or when you simply want to reduce the loss potential and time decay exposure of the position so some traders simply do not like to have all of that negative time decay exposure and don't like having such a high breakeven price so they'll opt for a call spread as opposed to buying a call option outright so what kind of comes down to personal preference and what your overall outlook for the stock price is that will help you determine when to buy a call option by itself or went to buy a call spread as opposed to just that call option well that wraps up this video on call options and call spreads I hope you enjoyed it and found it to be very valuable if you did please go ahead and give this video a like subscribe to our youtube channel so you can get all of our videos in the future and since we cover so much content please feel free to drop a comment down below if you have any questions [Music]

Channel: projectfinance

Views: 21,783

Rating: 4.9630995 out of 5

Keywords: long call vs long call spread, long call, long call option, long call spread, buying call spreads, options strategy comparison, bull call spread, call vertical spread, options strategies, trading options, call options, buying calls, buying call options, options for beginners, calls, tos, thinkorswim, trading strategy, trading, option strategies, vertical spread, options trading, options, stocks, call option, how to trade options, stock market

Id: E7sKQ4cif5Y

Length: 29min 53sec (1793 seconds)

Published: Mon Nov 13 2017