Long Call vs. Covered Call: Option Strategy Showdown

Understanding Long Call and Covered Call Strategies

Long call and covered call strategies are two common approaches in options trading that involve call options, but they serve distinct purposes within an investment portfolio. A long call is typically used as a speculative strategy, allowing investors to benefit from upward movements in a stock with relatively low upfront costs. In contrast, a covered call is a more conservative approach, often used by investors who already own shares and want to generate additional income.

A financial advisor can assist in determining which of these strategies aligns best with your investment goals and risk tolerance.

What Is a Long Call?

A long call is one of the most straightforward options trading strategies. It involves purchasing a call option, which gives the investor the right (but not the obligation) to buy a stock at a predetermined strike price before the option expires.

When an investor buys a long call, they pay a premium for the option. If the stock price rises above the strike price plus the premium paid, the investor can either exercise the option to purchase the stock or sell the option contract for a profit. The potential loss is limited to the premium paid, while the potential profit is theoretically unlimited as long as the stock continues to rise.

For example, if an investor purchases a call option on XYZ stock with a strike price of $50, paying a $3 premium, and XYZ rises to $65, the option is worth $15 ($65 – $50). Subtracting the $3 premium, the investor nets $12 per share in profit. However, if the stock remains below $50, the option expires worthless, and the investor only loses the $3 premium.

When to Use a Long Call

A long call is ideal when you have a bullish outlook on a stock but want to limit your downside risk. It's also beneficial for investors with smaller amounts of capital who seek leveraged exposure to price movements.

Pros: - Low upfront cost - Limited loss potential - Unlimited upside

Cons: - Time decay erodes value - High probability of expiring worthless - No gain if the stock does not move

What Is a Covered Call?

A covered call is an income-generating strategy that combines stock ownership with selling call options against those shares. With a covered call, the investor owns at least 100 shares of stock and sells a call option with a strike price above the current market price. The investor collects a premium from the sale. If the stock remains below the strike price, the option expires worthless, and the investor keeps the premium as income. If the stock rises above the strike price, the option may be exercised, and the investor must sell their shares at the agreed strike price.

This strategy provides income through premiums but caps the upside potential since gains above the strike price are forfeited.

For instance, if an investor owns 100 shares of XYZ stock trading at $50 and sells a covered call with a $55 strike price, collecting a $2 premium per share ($200 total), and XYZ stays below $55, the investor keeps the $200 premium. If XYZ rises to $60, the investor is forced to sell at $55, limiting their profit but still keeping the $200 premium.

When to Use a Covered Call

A covered call is suitable when you have a neutral to mildly bullish outlook on a stock. Investors often use it when they already own shares and want to generate additional returns while holding them.

Pros: - Generates income - Provides limited downside protection - Can work well in flat markets

Cons: - Caps upside potential - Still exposes the investor to losses if the stock declines significantly

Long Call vs. Covered Call: Key Differences

While both strategies involve call options, their purposes and risk profiles differ substantially in several key areas:

Investment Objective:
A long call is for speculation on rising stock prices, whereas a covered call is for generating income from owned shares.

Capital Requirements:
A long call requires only the premium cost, making it accessible with less capital. A covered call requires stock ownership, often a much larger investment.

Risk Tolerance:
Long calls carry the risk of losing the entire premium but no more. Covered calls carry stock market risk if the stock declines, though the premium provides a small cushion.

Return Potential:
Long calls have unlimited profit potential. Covered calls have capped upside but consistent income through premiums.

Tax Implications of Long Calls vs. Covered Calls

Taxes are another important factor when deciding between a long call and a covered call. With long calls, profits are taxed as capital gains—short-term if held under a year and long-term if held over a year. Losses may offset other capital gains.

With covered calls, however, the premium income is taxed as short-term capital gains, even if the stock is held long-term. If the stock is sold when the call is exercised, any gains are subject to capital gains tax based on the holding period.

Because tax rules can be complex, especially for options, it's often worth consulting with a financial advisor or tax professional.

Long Call vs. Covered Call: Which Is Right for You?

The decision between a long call and a covered call comes down to your investment goals, risk tolerance, and market outlook. If you want leveraged exposure to a rising stock with limited downside, a long call may be the better fit. On the other hand, if you already own shares and want to generate income while capping your upside, a covered call may be more appropriate.

Bottom Line

A long call allows an investor to control a stock for a set time and profit if the price rises above the strike, risking only the premium paid if it does not. A covered call involves owning the stock and selling calls against it, generating income from premiums while capping upside if the stock rises beyond the strike. The long call is growth-oriented and higher risk, while the covered call is income-oriented and more conservative.

Investment Planning Tips

A financial advisor can help you develop an investment strategy and manage risk for your portfolio. Finding a financial advisor doesn't have to be hard. There are tools available that match you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.

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