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The success of a call buying strategy depends primarily on one's ability to select stocks that will go up and to time the selection reasonably well. Thus, call buying is not a strategy in the same sense of the word as most of the other options strategies.
Most other strategies are designed to remove some of the exactness of stock picking, allowing one to be neutral or at least to have some room for error and still make a profit. Techniques of call buying are important, though, because it is necessary to understand the long side of calls in order to understand more complex strategies correctly.
Call buying is the simplest form of options investment, and therefore is the most frequently used option "strategy" by the public investor.
The main attraction in buying calls is that they provide the speculator with a great deal of leverage. One could potentially realize large percentage profits from only a modest rise in price by the underlying stock. Moreover, even though they may be a large percentage-wise, the risks cannot exceed a fixed dollar amount - the price originally paid for the call. Calls must be paid for in full; they have no margin value and do not constitute equity for margin purposes.
Example: Assume that XYZ is at $48 and the 6-month call, the July $50 is selling for $3, thus with an investment of $300, the call buyer may participate, for 6 months, in a move upward in the price of XYZ. If XYZ should rise in price by 10 pints(just over 20%), the July $50 call will be worth at least $800 and the call buyer would have a 167% profit on a move in the stock of just over 20%. This is the leverage that attracts speculators to call buying. At expiration, if XYZ is below $50, the buyer's loss is total but is limited to his initial $300 investment, even if XYZ declines in price substantially.
Although this risk is equal to 100% of his initial investment, it is still a small amount relatively. One should normally not invest more than 15% of his risk capital in call buying, because of the relatively large percentage of risks involved.
Some investors participate in call buying on a limited basis to add some upside potential to their portfolios while keeping the risk to a fixed amount. For example, if an investor normally only purchased low-volatility, conservative stocks because he wanted to limit his downside risk, he might consider putting a small percentage of his cash into calls on more volatile stocks. In this manner, he could trade higher-risk stocks than he might normally do. If these volatile stocks increase in price, the investor will profit significantly. However, if they decline substantially - as well they might, being volatile - the investor has limited his dollar risk by owning the calls rather than the stock.
Editor: Eli
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