• In options trading, going long means owning one of two types of options: a long call and a long put
  • A long call option gives you the right to buy stock at a preset price in the future. A long put option lets you sell it
  • Long positions hedge risk: If the stock doesn’t move as hoped, the option expires at little cost to you

A long position in investing basically means to buy or own a stock. Generally, you do so because you expect it to increase in value in the future – hence, you’re holding it for the long-term.

But a long position also has a specialised meaning, having to do with options and options trading. It refers to buying a specific kind of option, based on your belief as to where the price of a stock (or another asset) is headed.

Let’s examine how a long position in options, or “going long” as the traders say, works.

What is a long position in options?

In the options-trading world, taking a long position, or going long, means you’re purchasing an option. An option is a contract that gives you the right to buy or to sell shares for a preset price (or “strike price”) on or before a future date, usually within the next nine months. It’s an opportunity to do this trade, but not a commitment – so, an option.

Fast fact: When you purchase an option, the only thing you pay upfront is the premium, or fee, for the option itself.

There are two types of long options, a long call and a long put.

  • A long call option gives you the right to buy, or call, shares of a named stock for a preset price at a later date
  • A long put option does the opposite: It gives you the right to sell, or put, shares of that stock in the future for a preset price

 

How a long call option works

If you believe a certain stock is going to go up in price in the coming days, weeks, or months, you can purchase a long call option to buy that stock for today’s price sometime in the future and make a profit by selling it on the stock market at the then-higher price.

Example: You believe ABC stock, selling today for $US100 a share is going to be worth more in a couple of months. You purchase a long call option contract for 100 shares, set to expire in three months, at a strike price (a preset price) of $US100 per share, and a premium (fee) of $US3 per share for the option itself.

ABC does as you expect and in two months shares are worth $US150 apiece. You exercise your option, buy 100 shares at $US100 each, sell them for $US150 each, and you’ve made a tidy profit of $US4,700.

Here’s the maths

$US15,000 from the sale of 100 shares @ $US150 on the stock market

– $US10,000 cost to buy those shares at the strike price

– $US300 cost of the original contract premium

= $US4,700 profit

How a long put option works

If you believe a company’s stock is due for a drop, you would purchase a long put option contract giving you the right to sell shares of that stock in the future for today’s (higher) price.

Example: You believe ABC is going to decline in a couple of months. You purchase a long put option contract for 100 shares, set to expire in three months, with a strike price of $US100 per share, and a premium of $US3 per share.

ABC does as you expected and in two months shares are selling for $US50. You buy 100 shares at $US50 each, exercise your option, and sell them for $US100 each, and you’ve made a tidy profit of $US4,700.

Here’s the maths

$US10,000 from the sale of 100 shares @ $US100 strike price

– $US5,000 cost to buy those shares at the lower market price

– $US300 cost of the original contract premium

= $US4,700 profit

Exercising your long call or long put option

Whether you buy a long call or a long put, you can’t make money unless you exercise your option. Exercising your option means to buy or sell before the expiration date set in the option contract.

Naturally, you’d exercise the option if things go the way you expect — the stock moves in the manner you thought it would, so you get to buy it (with a call) or sell it (with a put) at a price that’s better than the current market rate.

Why would you let the option expire without exercising it? Simple: The price of the stock goes against your prediction, moving in an opposite direction from the strike price. If that happens, the option becomes worthless. You let it expire, and you lose the premium you paid.

The good news is, that’s all you lose.

Why take a long position in options?

Going long lets you take chances with less risk. Both long calls and long puts limit your loss to the premium, the cost of the options contract. You don’t have to buy the stock (in a call) or sell the stock (in a put) unless you expect to profit — by the shares moving as you anticipated before the contract ends.

In contrast, in regular investing, you’re committed to an actual purchase. And that could cause you to lose a lot of money if the stock doesn’t move in the direction you expected.

In addition to being less risky, long options also include an unlimited profit potential to the upside in the case of a long call option or the downside with a long put option. As long as the stock is above or below your option’s strike price – for the call or the put, respectively – you stand to win.

Both types of options are considered long, in the sense that both are buy positions and both let you make money on the direction of the underlying stock. However, the long call is the more bullish sentiment, because you’re betting that the stock price will rise.

The long put option is a more bearish view because you’re anticipating, and hoping to profit from, a fall in the stock price.

Long put options and short selling

A long put option is somewhat similar in strategy to short selling, aka shorting. That’s when you sell stocks you’ve borrowed, aiming to buy them back later for less money, and pocketing the difference as profit. Both are bets that a stock’s share price will decline.

The key difference is, with a long put, you don’t have to actually borrow to buy the stock upfront and hope it falls in value before you have to repay it. You just reserve the right to do so before the end of the options contract. If the drop doesn’t happen, you just let the option expire.

A long put option can also serve as a hedge, or insurance, against a bad outcome with a long call option or an outright purchase of stock. Yes, you’re betting against yourself, in a way, but at least you stand to benefit a bit if the stock falls instead of rises, mitigating your overall loss.

The financial takeaway

With options, going long refers to a position in which you buy:

  • a long call option, meaning that you expect the underlying asset to increase in price, which increases the value of the option. This option is bullish on both the underlying stock and the option itself
  • a long put option, meaning you expect the underlying asset to decline in price, which increases the value of the put option. A long put option is bearish on the underlying stock but bullish on the outcome of the option

Long option positions require less investment, or cash down, than outright investments. Instead of spending thousands on a stock, you just spend a few hundred on the option, giving you more leverage for less money.

Of the two options, long calls are more common – or at least, what’s more commonly thought of as a long options position. And, like buying stock outright, they are essentially optimistic. Long puts, pessimistic bets that a stock will fall, are more often used as insurance against a bad outcome with a long call, or with an actual ownership position.

But in a way, both long options can be considered bullish: Both are buy positions, affording you a chance to make money on the moves of the underlying stock.

This article first appeared on Business Insider Australia, Australia’s most popular business news website. Read the original article. Follow Business Insider on Facebook or Twitter.