Short Call

Options trading is a type of investment that involves contracts between a buyer and a seller. The buyer of an option has the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a particular date. The seller, on the other hand, has the obligation to buy or sell the underlying asset at the buyer’s discretion.

What is a Short Call?

A short call, also known as a naked call, is an options trading strategy where the seller of the call option does not own the underlying asset. The seller believes that the price of the underlying asset will either remain stable or decrease during the option’s lifetime, and hence, they sell the call option to profit from the premium received.

The seller of a short call option has the obligation to sell the underlying asset to the buyer of the option at a predetermined price (known as the strike price) if the buyer chooses to exercise the option. The seller will receive the premium upfront, but if the underlying asset’s price rises above the strike price, the seller will face unlimited losses. Hence, they are considered risky and are suitable only for experienced traders.

Strategies for Short Calls

Short calls can be used as a standalone strategy or as part of a more complex trading strategy. Here are some of the most common strategies used:

• Covered Call: A covered call strategy involves owning the underlying asset and selling a call option on it. The call option sold is “covered” by the underlying asset, which limits the seller’s risk.
• Vertical Call Spread: A vertical call spread strategy involves selling a call option with a lower strike price and buying a call option with a higher strike price. This strategy limits the seller’s potential losses while also capping their profits.
• Iron Condor: An iron condor strategy involves selling a call option and a put option simultaneously while also buying a call option with a higher strike price and a put option with a lower strike price. This strategy limits the seller’s potential losses while also capping their profits.

Examples of Short Calls

Let’s look at some examples to better understand the concept.

Short Call Example #1

Suppose an options trader sells a call option for XYZ stock with a strike price of $50 and an expiration date of one month. The premium received for selling the option is $2. If the underlying stock’s price remains below $50 until the expiration date, the seller will keep the premium as profit. However, if the stock price rises above $50, the seller will face unlimited losses.

Short Call Example #2

Suppose an options trader sells a call option for ABC stock with a strike price of $100 and an expiration date of three months. The premium received for selling the option is $5. The trader believes the stock price will remain stable or decrease during the option’s lifetime. However, if the price of the stock rises above $100, the seller will face unlimited losses.

Conclusion

Short calls in options trading can be a profitable strategy for experienced traders who believe that the price of the underlying asset will remain stable or decrease during the option’s lifetime. However, they are risky, and traders should understand the potential risks and rewards before implementing this strategy. Additionally, traders should consider using short calls as part of a more comprehensive trading strategy, such as covered calls, vertical call spreads, or iron condors.