Short Call Option Strategy

 

The short call option , also known as uncovered or naked call, consist of selling a call without taking a position in the underlying stock. For those who are new to options, they should avoid the short call option as it is a high-risk strategy with limited profits.  More advanced traders use a short call to profit from unique situations where they receive a premium for taking on risk. Let’s take a more in-depth look at the short call option strategy.

Investors open the short call strategy when the prediction for the underlying asset is bearish to neutral. Upon making the sale, the trader has an obligation to sell the stock at the strike price if the buyer of the short call exercises the option. This should not be confused with the short put option, where the seller has an obligation to buy the stock patterns at the strike price. In the chart above, once the stock moves past strike price A, the trader starts to lose their profit. Once it moves past the strike price by more than the premium received, they start taking a loss.

With the short put option strategy, the investor is betting on the fact that the stock will rise or stay flat until the option expires. If the put option expires worthless, out of the money (above the strike price), then the trader keeps the entire premium, which represents their maximum profit on the trade. When it comes to single option trades, selling a put option is one of two market strategies, the other being the long call option.

With this strategy, it’s in the investor’s interest if the call option has no value at expiration, thus expiring worthless. When executing this option strategy, it’s a good practice to wait until the strike price is one standard deviation out of the money (the stock price is lower than the strike price). However, the strike price well negatively affect the premium received, the more risk, the higher the reward.

With a short call, the trader wants the implied volatility (IV) to decrease as this will reduce the price of the options they’re short. Here, if the investor decides to close the position before the expiration date, the trade will cost them less to buy back. Similarly, decreasing time to expiration is also a positive factor with this strategy because the less time to expiration, the lower the value of the call option, enabling the investor to close the position for less.