Long Options

Long options are any options, calls or puts that you pay for in order to acquire. When you purchase an option, payment is called a debit and you're considered to be long, as opposed to short options which are those option positions that you sold, or wrote, and for which you received cash (and termed a credit).

Having long options in your portfolio does not by itself mean that you're betting that the underlying stock will go up. Recall, for example, that a long put increases in value as a stock declines.

Let's look at a couple of quick examples.

Long Call

A long call is simply a call you've purchased. Supposed the XYZ Zipper Company is trading at $14/share. Over the last 18 months, the stock has really been beaten down. The company has had poor earnings the last several quarters as a global recession has dramatically slowed pants consumption.

But you sense a turnaround in the air. Everywhere you look, people are sporting new jeans. Denim is back, baby. And earnings release for XYZ is scheduled in two weeks.

You discover that the $15 call (strike price) for the front month (current expiration cycle) is available for $2/contract (or a $200 debit since each contract represents 100 shares of stock).

Let's assume your analysis is right and the company produces some blowout numbers. The stock does, in fact, rocket all the way to $20/share. The value of your long call has also increased. The call you paid $2/contract is now going to be worth at least $5/contract (intrinsic value alone = $20/share price less $15 strike price, or $5/contract).

Long Put

Now let's assume an opposite scenario. Imagine instead that zipper mania has engulfed the country. Everywhere you look, the media is hyping zippers. The XYZ Zipper Company is being touted as the ultimate blue chip company. Everyone needs zippers, the reasoning goes, therefore every portfolio needs zipper stock. Unlike the zipper itself, XYZ stock seems capable of only going in one direction--up.

A contrarian at heart, you believe that the stock has gotten way ahead of itself. It currently trades at $85/share. You decide to buy a long put expiring in three months at the $85 strike price for $5/contract.

You nail the prediction and three months later the stock has fallen all the way down to $60/share. The long put you paid $5/contract ($500) for is now worth $25/contract ($85/share less the $60 strike price).