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The OTM long call strategy has the highest reward to risk ratio of any long call, but also the lowest probability of success.

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Strategy: Long Call, Out-of-the-Money

Long Call Out of the Money Option Graph

The Outlook: Extremely bullish. At expiration, the stock must have risen by the amount of the OTM strike price, plus the initial debit, just for the option to break even. It must have risen more for the option to show a profit.

The Trade: buy call(s), using the next strike price above the current stock price.

Gains when: stock rises enough by the expiration date to overcome the higher strike price and the initial debit.

Maximum Gain: unlimited.

Loses when: stock goes down, does not rise, or does not rise enough by the expiration date.

Maximum Loss : limited to the initial debit.

Breakeven Calculation: Strike Price bought + Initial Debit.

Advantages compared to stock: much less capital required, vastly increased leverage, "built-in" stop loss.

Disadvantages compared to stock: much greater risk of 100% loss of the capital invested, no dividends, limited life, more stock movement needed to be profitable.

Volatility: after entry, increasing implied volatility is positive.

Time: after entry, the passage of time is negative.

Margin Requirement : None. Initial debit must be paid in full.

Variations: Long Call, ITM; Long Call ATM.

Synthetic Equivalent: Long Stock plus Long Put at the strike used for the OTM call.

Comments

  • Buying an Out-of-the-Money call is the least expensive long call, and the least likely to show a gain at expiration.
  • OTM long calls are used by speculators expecting a quick upward move in a stock. A speculator who gets the timing right can double his investment in a day or two.
  • OTM long calls can be used to "bottom fish" in a stock or index ETF, at much less dollar cost than buying the stock or ETF. If the speculator really is buying the bottom, the percentage gains can be substantial.
  • OTM long calls can be used to speculate on possible big moves at earnings time. If the speculator is correct, large percentage gains are possible. If wrong, the dollar loss is relatively low and limited.
  • Like all long calls, OTM long calls have a "built-in" stop loss. You can only lose as much as the call cost.
  • A trader wanting a better probability of the option ending up In-the-Money might want to use ATM calls instead. A trader wanting the best probability of a gain nearly dollar-for-dollar with a rise in a stock might want to use ITM calls instead. See the ITM, ATM, OTM? page for more information.

Exits

  • Since this is an extremely bullish position, the trader is obviously expecting the stock to move much higher. If the stock does not move high enough, and the time to expiration gets to just a couple weeks, it is usually wise to exit the trade, taking less than the maximum possible loss.
  • However, since this is a very low cost and speculative position in the first place, it is not inconsistent with that strategy to just hold on until expiration. Just like gambling, every once in a while there might be a big winner if you stay in the game.
  • If the stock moves higher as expected, speculators usually take gains by selling the call at a higher price. However, they can also roll out to a later month, or exercise the call to buy stock at the strike price.

Adjustments

  • Since a long call is a component of many other option strategies, a long call position can sometimes be adjusted or converted to those strategies.

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