Selling a Call Option
What is Selling a Call Option?
Call option sellers, also known as writers, sell call options hoping that they become worthless when they expire. As a call seller, you have given someone else the right but not the obligation to buy an underlying asset at a predetermined price up to a specific time in the future. Profit is made here by receiving a premium when selling the options and the options subsequently expire worthless.
If you think that the price of XYZ PLC, which is currently 405, is going to decline or move sideways then you could sell a call to profit from this move. Let’s imagine you have sold the 440 calls and taken in a premium of 7. If the market stays below 440 you will simply keep the premium as your option would expire worthless.
What is a Naked Call Option?
Selling a naked call (a call without holding a stock position) is considered to be very risky since it can result in a substantial loss, as technically there is no limit to how high a stock can go. If the option buyer exercises their option when the underlying security price rises above the option strike price to say 500 you will have to go into the market and purchase shares you have sold to the option buyer at the strike price (440) at 500.
This would result in a loss of 60 minus the option premium of 7 so a net loss of 53. Individual shares can rise very quickly especially if, for example, they are subject to a takeover bid.
Although a profit can be made by selling options and receiving a premium, there is always a risk of the market rising and causing losses.
Short Call Summary
CONFIGURATION:
- Selling a call option
OUTLOOK:
- Bearish to a neutral stance
TARGET:
- The option just needs to expire below the strike price you sold
PROS
- Benefits from time decay and falling volatility
- Can be used as a type of hedge against underlying assets. (See Covered Call)
CONS
- Higher risk strategy
- Can be exercised early if American style
- Potentially unlimited losses
- Can be margin intensive if underlying asset rises sharply
