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There are plenty of ways to profit on a stock's movement beyond investing in the actual stock itself. Options provide a nearly endless array of strategies, due to the countless ways you can combine buying and selling call option(s) and put option(s) at different strike prices and expirations.
A call is an options contract that gives the owner the right to purchase the underlying security at the specified strike price at any point up until expiration. A put is an options contract that gives the owner the right to sell the underlying asset at the specified strike price at any point up until expiration.
One of the most basic positions that an investor can take is a long call.
The basic setup
A long call is simply owning a call option. You would purchase a call option if you believe that the stock is going to rise, since the value of a call goes up if the underlying stock price goes up. However, any option has the risk of expiring completely worthless upon the expiration date, so buying options is considered a speculative strategy.
For example, let's say a stock is trading at $50. If you believe that the stock will go up, you could consider purchasing a $55 call. Let's say that the premium for that call is $2.
Maximum loss: premium paid
Any time that you purchase an option, the most that you can lose is the premium that you paid for the option. This is true for both calls and puts. This occurs if the option is out-of-the-money upon expiration, in which case it expires worthless.
In this example, you would lose the full $2 in premium if the stock closes upon expiration below $55, since the call would then be worthless.
Maximum gain: unlimited
There is no theoretical upper-bound limit to stock prices, so the maximum gain is potentially unlimited. Of course, stock prices don't increase to infinity in reality, so this gain is purely hypothetical.
In this example, if the stock was acquired by another company for $200 per share, you would enjoy substantial gains of $148.
Breakeven: strike price plus premium
The breakeven on a long call is the strike price plus the premium. If the stock closes at this price upon expiration, the gains associated with the trade will exactly offset the upfront premium paid.
In this example, if the stock closed at $57, you would gain $2 on the trade itself (buying at $55 and selling at $57). This would offset the $2 in premium paid upfront.
