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Long Call Vertical

Analyzing the risk profile of a long call vertical

Risk Profile & Summary

Standard Setup

Long call verticals are established by selling a lower delta call and purchasing a higher delta call. While not a requirement, the short strike is usually placed
while the long strike is placed
The strikes are often equidistant from the current share price in an attempt to create a 1:1 risk/reward ratio (meaning you can make as much as you can lose, with a 50%
Advanced traders should pay close attention to the
in both options. Selling an option with greater extrinsic value than the option you are buying will result in a POP slightly higher than 50%. This is because you would be buying the spread for less than
allowing you to take slight advantage of positive
Risk Profile: Long 25 Delta/75 Delta Call Vertical
A long call vertical is a
that allows us to cap our risk at comfortable levels. They also have a limited profit potential. You want both strikes to move
for a chance at maximum profit. If your long strike moves
you will be at risk of maximum loss.
At trade entry, long call verticals typically offer little to no
decay and often times, depending on strike selection, carry negative theta. This simply means they aren't ideal for capitalizing on the passage of time. If they carry negative theta, they will actually be disadvantaged by the passage of time giving them a lower POP. As the share price changes, so too will their theta levels. As the price gets closer to the long strike or below, theta will become more negative, and the position will feel greater pain as time passes. As the price approaches the short strike or above, theta decay will become positive and the position will benefit from the passage of time.

Why We Do This

Long call verticals are typically used as a low cost/limited risk way to bet on rising
value. Unlike some of the other strategies we've covered so far, like
or naked
typical long call verticals depend almost exclusively on directional correctness to turn a profit. If the underlying decreases in value or stays the same, this strategy will likely lose money or, at best,
If you manage sell your short option for greater extrinsic value than you pay for your long option (as mentioned above), such a setup might give you a tiny amount of buffer room to be directionally wrong, however the amount may not be very significant. When established properly, your odds of profit will essentially be 50%.
One unique advantage to buying a call vertical has to do with
As discussed in Pricing Options: Implied Volatility, when IV increases, it is indicating that demand for options is rising, increasing their extrinsic value. Rising option value can benefit us when we have a debit spread like the long call vertical. Typical products, such as
and
often see their IVs rise when their values decrease. This is because investors in these products fear losing money as their values fall, so they buy options to
their risk. Increased buying raises the demand, and in turn, the value of the options. Since long call verticals are a bullish strategy, they will lose as the underlying value falls. Their extrinsic value, however, will likely rise with IV creating a natural hedge of the position. Even though you might be losing money, if IV is increasing it can help to slow the bleeding (to a certain extent).

The Risks

The risk of a long call vertical is realized when the underlying price falls. Maximum loss happens if the spread expires completely
The most you can lose on a long call vertical is the amount you pay for the spread. With that in mind, never buy a vertical worth more than you're comfortable losing. Long verticals do not typically have favorable odds of success, and are often disadvantaged by
contraction and the passage of time.

Summary

Assumption Bullish
A long call spread profits when the share value rises.
Cost Basis Debit
The cost basis for a long call vertical is equal to the total debit paid (plus
and fees).

Cost Basis = Debit Paid
POP ≈50%
A properly established long call vertical will have around a 50% probability of profit. Collecting a larger extrinsic value for the short option than paid for the long option can increase these odds slightly above 50%. Vise-versa, paying more extrinsic value for the long option than collected for the short can reduce the odds below 50%.
Capital Requirement Low (depending on strike width)
Depending on the width of the strikes, long call verticals typically have low capital requirements relative to other strategies. You only need enough to cover the cost of the spread. No additional capital should be required after you've paid for it.
Break Even (before commission and fees) The break-even for a long call vertical is calculated by adding the debit paid to the long strike price.

B/E = Long Strike + Debit Paid
Maximum Profit Limited
Long call verticals have limited profit potential. Max profit is calculated by subtracting the debit paid from the width of the strikes.

Max Prof = High Strike - Low Strike - Debit Paid
Maximum Loss Debit Paid
The maximum amount you can lose on long call vertical is the total debit paid.

Max Loss = Debit Paid
Capital Allocation (per position) <1% per position
Long call verticals offer little to no edge in terms of POP. There are also almost no defensive tactics should this strategy fail. The best defense is to keep these positions extra small. 1% is the most I'd be willing to risk on this type of spread.
Profit Target 25-50%
Due to the low POP, I'm generally happy with 25% of max profit. I may hold out for more if light on positions, but 50% is a homerun and an automatic close.
Delta (P/L rate of change) Positive, Dynamic
Long call verticals carry dynamic, positive delta. This means they are a bullish strategy with fluctuating delta. Delta is highest when the share price is between the strikes, but approaches zero as the spread moves deep ITM, or far OTM.
Theta (Time decay) Reverisble
Properly established long call verticals do not have a strong reliance on theta at trade entry. The extrinsic value between the short and long calls should cancel each other out or, ideally, be slightly positive. As the spread moves OTM, theta may become slightly negative. As the spread moves ITM, theta may become slightly positive.
Vega (Implied volatility sensitivity) Reversible
Vega levels can change depending on the proximity of share price to strike. If the share price approaches your short strike, vega may turn slightly negative. If it gets closer to your long strike, it may become more positive. If the share price is near your break even, vega may become more neutral. This metric can also vary with
and spread width.
Gamma (P/L Momentum) Reversible
Long call verticals carry dynamic gamma which means their gamma changes depending on the juxtaposition of the strikes and the share price. Gamma becomes most positive when the share price is near the long strike (meaning it will speed into profit, and slow into loss). It becomes most negative when it is near the short strike (meaning it will slow into profit, and speed into loss). It approaches zero as the spread moves far OTM, or deep ITM (meaning its rate of P/L should remain constant). It also approaches zero as the share price nears the center of the strikes.

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