Stock Option Basics: The Short Call

There are essentially four elements that provide the basis for all Option strategies. These elements include: The Long Call, the Short Call, the Long Put, and the Short Put. By combining Calls and Puts in creative fashions, Options traders are able to generate income strategies and limit risk. This article introduces the second such element, the Short Call.

The Short Call seller or writer receives the premium or value of the sold Call in exchange for the obligation to provide an equal number of shares of stock at the Strike Price should the Call expire In the Money. The goal of the Short Call writer is to have the Call expire worthless Out of the Money. Writing Calls is primarily a neutral strategy with a tolerance for a little upward movement of the underlying security.

While it is possible to Short Calls without owning the underlying stock or security, it isn’t advisable. Selling “Naked� Calls is a high risk strategy.

A Risk Graph of the Short Call is provided below:

On the Risk Graph, we see that the Call was sold for $15. The Short “Naked� Call is profitable until it reaches the Strike Price at which it was sold. Above the Strike Price the seller will be required to provide the stock upon being exercised. The potential loss on this trade is unlimited. What makes the potential loss unlimited is that the price of the stock may rise indefinitely. The Call seller may be required to present the stock at say, the $75 Strike Price, but he may be forced to buy the stock at $100 if it rises that high. Selling naked Calls can have a large potential downside. Constant attention to where the stock is headed is part of managing this trade. It is safer to Short Calls and also own the underlying security. In other words, turn it into a Covered Call trade. We have written extensively on the Risks and Rewards associated with Covered Calls on this site as well.

The best outcome for the Short Call Seller is for the Option to expire Out of the Money, leaving the seller pocketing all of the premium. The Naked Call writer would like nothing better than for the stock value to decline. A neutral to bearish posture of the stock is best for Naked Call writing.

Bear in mind, however, we absolutely do not recommend Naked Call or Put writing. The risks to your trading health are far too great. It could end your trading career because you may incur an obligation to provide shares at a price that is greater than your account size. That means your other tangible assets outside of your trading account could be at risk. Taking that kind of risk, just isn’t worth it.

Optionsmentoring.com is all about: 1) teaching you to understand the risks before you place a trade; 2) teaching you to properly put on the trade so that the odds are heavily in your favor; 3) teaching you how to make adjustments to your trade if it moves in one direction or the other; 4) providing you with sufficient detail to really understand how to trade Option Strategies; 5) coaching you for success; and 6) providing you with free trade setups for several months on a weekly basis so that you can generate regular cash flow.