What are the characteristics of this option strategy?
ETF options let traders speculate on the direction of a fund, or hedge shares they already own, using strategies such as long calls, long puts, straddles, strangles and many more. The example used throughout this page is the Long Call ETF option strategy, a bullish strategy designed to profit from an expected increase in the underlying exchange-traded fund’s (ETF) price. It consists of buying call options on the ETF and paying a premium for them.
Is this a bullish, bearish or neutral strategy?
This strategy is a bullish strategy, as it is designed to profit from an expected increase in the underlying ETF’s price.
Is this a beginner or an advanced option strategy?
Buying a call is a beginner-level strategy in its mechanics: one leg, one order, and the most you can lose is the premium you paid. What makes it harder than it looks is that the option expires, so losing the entire premium is the normal outcome when the ETF fails to move far enough in time. Traders still need a good working knowledge of the risks, costs and rewards involved before they can use it effectively.
In what situation will I use this strategy?
This strategy should be used when traders think the underlying ETF will increase in value over the course of their position. It is useful for traders who are looking for a higher degree of leverage and who are comfortable with the risks associated with options trading. They can also use the strategy to speculate on direction of the instrument movement, as well as to hedge positions in the underlying shares.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The risk-reward profile and probability of profit of this strategy will depend on the strategy’s entry and exit points and strike prices. Generally, profits in this strategy increase without limit as the underlying ETF rises above the strike price, while the risk is capped at the premium you paid for the option. The risk, meanwhile, will increase if the underlying ETF declines in price, but is limited by how much you paid for the option.
How is this strategy affected by the greeks?
The greeks, such as Delta, Gamma, Theta and Vega, will have a direct effect on the performance of this strategy. Delta measures the rate at which the option value changes in response to a change in the price of the underlying ETF, Gamma measures the rate of change of Delta in response to a change in the price of the underlying ETF, Theta measures the rate of time decay of the option, and Vega measures the rate of change of the option value in response to changes in the volatility of the underlying ETF.
In what volatility regime (i.e VIX level) would this strategy be optimal?
A long call is long vega, so it gains value if implied volatility rises after you buy it. That is not the same thing as buying when volatility is already high. A high VIX means you pay more for the same strike and your breakeven sits further away, which makes the trade harder, not easier. The better entry is usually when implied volatility is low relative to its own recent range and you expect both the ETF and its volatility to rise from there.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
The simplest adjustment when the position is going against you is to close it and take the loss while some time value remains. Beyond that, you can roll down to a lower strike or out to a later expiration, both of which cost additional premium and increase the amount at risk, or sell a further out of the money call against your long call to turn the position into a call spread, which recovers some premium in exchange for capping the upside. Buying more calls at the same strike is averaging into a losing trade and raises the maximum loss rather than reducing it. Which adjustment makes sense depends on the trader’s risk tolerance and market conditions.
Where does this strategy typically fall in the range of commissions and fees?
This depends heavily on which ETF you trade. Options on the largest funds, SPY and QQQ among them, are some of the most heavily traded contracts listed anywhere, with penny-wide bid/ask spreads and very low friction. Options on small or niche ETFs can be extremely thin, and there the spread you cross on the way in and out will cost more than the commission does. Check the bid/ask spread and the open interest of the specific contract before assuming the cost is small, and look for brokers who offer competitive per-contract commissions.
Is this a good option income strategy?
No. Buying calls is a directional strategy, not an income strategy: you pay the premium up front and time decay works against you every day the ETF fails to move. Income comes from selling premium, for example a covered call on ETF shares you own.
How do I know when to exit this strategy?
The relevant reference point is the breakeven, which is the strike plus the premium paid ($415 + $2.50 = $417.50 in the example below); at any price below that the position is still losing money at expiration, so exit decisions should weigh the remaining time value against how far the ETF still has to travel. However, traders should also factor in other factors such as time decay, volatility and market conditions before exiting a position.
How will market makers respond to this trade being opened?
Market makers will react to this trade by adjusting the bid/ask spread in order to make a profit. They will adjust the spread depending on the liquidity of the underlying ETF, the expected level of volatility, and the proximity of the option strike price to the current price of the ETF.
What is an example (with calculations) of this strategy?
For example, consider a trader who believes the SPDR S&P 500 Trust ETF (symbol SPY) will rise from the current price of $410 in the near future.
Assuming that we are bullish on the ETF SPY and believe that its price will increase in the near future, we could use a Long Call ETF option strategy to profit from this. In this case, we could set up the following trade:
Buy 1 SPY call option with a strike price of $415 for a premium of $2.50
The premium paid for the call option is the maximum potential loss for this strategy: $2.50 per share, or $250 for one contract covering 100 shares, and you lose all of it if SPY finishes at or below $415 at expiration. The potential profit is unlimited, as the value of the call option will increase as the price of the ETF SPY rises. The breakeven at expiration is $417.50, the $415 strike plus the $2.50 premium, so SPY has to rise about 1.8% from $410 just to get you back to flat.
If the price of the ETF SPY rises above the strike price of the call option ($415), the option would be in the money, and we could exercise the option to buy the ETF SPY at the strike price. Alternatively, we could sell the call option for a profit if the price of the ETF SPY rises and the value of the option increases.
Where does MarketXLS Help?
MarketXLS is a powerful financial and investment analysis platform, enabling investors to make informed decisions with up-to-date data, technical analysis tools and a wide range of financial information. The platform provides deep insights into different asset classes, including ETFs, stocks, options, commodities and futures with dedicated sections for different markets. MarketXLS offers a comprehensive set of tools to help traders analyze and manage market opportunities and to take advantage of the Long Call ETF Option strategy. For example, you can use the Long Call Options Trade worksheet on the MarketXLS platform to understand the risks, costs and rewards of a long call ETF option trade in the SPY ETF with a few clicks.
MarketXLS makes it easy to understand and analyze the risks and rewards involved in different ETF option strategies so you can make the most informed decision. With the help of the MarketXLS tool, you can size the Long Call ETF Option strategy properly and see exactly what the trade stands to make and what it stands to lose before you place it.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
“Managing Your Risk with Option Implied Volatility”
Long Calendar Spread Using Puts Option Strategy
ITM Options: A Strategic Investing Tool
Long Call Options Trade/Strategy-How To Manage And Track
How to hedge a drop in S&P 500 Using MarketXLS