Short Call Option Strategy

When you expect the price of a stock to fall, you do the opposite of the Long Call. You can sell Call options, when you are highly bearish on a stock. It is important to clear that, this position has a limited profit potential and the possibility of large losses. It is a risky strategy since the seller of the Call is exposed to unlimited risk. It is suggested not to carry overnight positions. Also, you should always strictly comply with Stop Loss in order to regulate your losses.

To limit losses, some traders often apply a short call while owning the underlying stock. This is known as a Covered Call.

  • When to Use:Investor is highly Bearish on a stock / index.
  • Risk: Unlimited
  • Reward: Limited to the Premium.
  • Breakeven: Strike Price + Premium
  • Profit when: The underlying security closes below the strike price.
  • Loss when: The underlying security closes above the strike price.

Let’s understand with an example:

Short Call Option Strategy

Short Call Payoff chart: In the above figure, we have underlying price on the ‘X’ or the horizontal axis and Payoff/profit on the ‘Y’ or the vertical axis.

Here, I shorted 1 lot of NIFTY.
Current Nifty index 12000
Call OptionStrike Price (Rs.)11900
PayingPremium (Rs.)50
Break Even Point (Rs.) (Strike Price + Premium)11950

This strategy limits the profits to the amount of premium I paid (Rs.50). But the risk is unlimited in case of rise in NIFTY.

This strategy is used when an investor is aggressive and strongly believes that the price is going to fall. This is a risky strategy as, if the stock price rises, the short call loses money at a fast pace and the seller may suffer significant losses. Since the trader does not own the underlying stock that he is shorting, this strategy is often called Short Naked Call. Again, the maximum profit to be made from this strategy is the amount of premium paid.

Conclusion

  • When you short a call option, you do it with bear expectations from the market.
  • While shorting calls, you should comply with Stop Loss in order to regulate your losses.
  • A short call strategy offers unlimited risk and limited profit (premium).
  • Some traders, in order to limit losses, often apply a short call while owning the underlying stock. This is known as a Covered Call.
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