Long Call Grand Slam

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Includes: BAC, XLF
by: Russell Gold

Never let the fear of striking out get in your head.

~Babe Ruth

In his 22-year baseball career, Babe Ruth had 1,330 strike outs. "The Bambino" also had 714 home runs -- including 16 grand slam home runs. From trade-to-trade, many stock options traders strike out, and every once in awhile, they hit a home run, or better yet, a grand slam. One way to hit a home run is to employ either a long call or long put strategy.

In stock options, a call position becomes more valuable as the price of the underlying stock appreciates relative to the strike price. The profit potential for trading a long call is considerable, and the original investment is the only potential loss. A long call is simply the purchase of one or more option contracts (1 contract = 100 shares). As a trader you use a long call option when you are bullish on a particular stock or market direction. You can also use a long call strategy if you believe the markets could become volatile in the near future. Purchasing call options is a different way to profit from a bullish market without buying shares of stocks. Implementing long call strategies is not difficult at all.

To take advantage of financial volatility ahead of the Jackson Hole Bankers Meeting in late August -- an important date for investors -- I will explain how to trade a long call option strategy. Bank of America Corporation (NYSE:BAC) -- the twelfth largest bank in the world -- closed at $7.22 a share August 1, 2012. Below is a calendar of Bank of America options expiring at the market close Friday, January 18, 2013.

(click images to enlarge)

Bank of America (<a href='http://seekingalpha.com/symbol/BAC' title='Bank of America Corporation'>BAC</a>) Stock Option Calendar January 18 2013 Long CallClick to enlarge

To employ the long call option strategy, a trader enters in one single call position. In this example, Bank of America BAC closed at $7.22 August 1, 2012. BAC has been trading in a tight $7 to $10 range for the past six months. The options I'll be trading expire at the close on Friday, January 18, 2013. Given the time frame, this is a somewhat high risk trade with a rather incredible return. Therefore, the investment in this trade should be manageable. I spent a total of $1,350 to execute the long call strategy.

To employ the long call strategy using Bank of America BAC shares, a trader enters into one option position -- one call. Let say the trader wants to purchase 50 contracts (1 contract = 100 shares) for a call position. Say the call is for a $9.00 strike price and costs $1,350 ($0.27 per option contract x 100 shares x 50 contracts).

If you have 50 contracts for January 2013 -- 9.00 calls that cost $1,350 -- you have the right (meaning you can close the trade at anytime no matter the price of a stock) to sell 5,000 shares (1 shares = 1 contract) of BAC until January 18, 2013. If shares of BAC increase to $10.00 after the close on the expiration date (Jan. 18, 2013) the option is now worth $1 dollar a contract, equal to $5,000 ($1.00 per option contract x 100 shares x 50 contracts) So subtracting the option value, $5,000, from the original investment, $1,350, you get a total gain $3,650 -- a 270% Home Run.

Here is another example of how to trade options with a long call strategy. Keeping in mind the Jackson Hole Bankers Meeting in late August, the Financial Select Sector SPDR (NYSEARCA:XLF) is of interest. The Financial Select Sector SPDR, an Equity Traded Fund ETF, comprises of diversified financial services, insurance companies and commercial banks. The Financial Select ETF closed $14.59 a share August 1, 2012. Below is a calendar of the Financial Select Sector SPDR options expiring at the market close Friday, November 16, 2012.

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Again, employing a long call option strategy, the trader enters in one single call position. In this example, the Financial Select Sector SPDR XLF closed at $14.59 August 01, 2012. XLF has been trading in a tight $13 to $16 range for the past 6 months. The options I'll be trading expire at the close on Friday, November 16, 2012. Given the shorter time frame, this is a high risk trade with a grand slam return. Therefore, an investment in this trade should be smaller than the previous example. I spent a total of $500 to execute this long call strategy.

Click to enlarge

To employ the long call strategy using Financial Select Sector SPDR XLF shares, a trader enters into one option position -- one call. Let say the trader wants to purchase 10 contracts (1 contract = 100 shares) for a call position. Say the call is for a $15.00 strike price and costs $500 ($.50 per option contract x 100 shares x 10 contracts).

If you have 10 contracts for November 2012 -- 15.00 calls that cost $500 -- you have the right (meaning you can close the trade at anytime no matter the price of a stock) to sell 500 shares (100 shares = 1 contract) of XLF until November 16, 2012. If shares of XLF increase to $16.50 after the close on the expiration date (Nov. 16, 2012) the option is now worth $1.50 a contract, equal to $1,500 ($1.50 per option contract x 100 shares x 10 contracts) So subtracting the option value, $2,000, from the original investment, $500, gives you a total gain $1,500 -- a 300% Grand Slam.

You might also want to study other option strategies before attempting to hit out-of-the-park home runs. Here are two other articles I wrote regarding stock option strategies: long straddle and long strangle. Both the straddle and strangle methods are more sophisticated, but less risky.

Note: A trader can sell the underlying -- in this case BAC and XLF -- anytime. He or she does not have to hold an option through the expiration date.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.