Do you know what a short call is in options trading? Short calls are the same as selling a naked call option, just a different name. You go short or sell a call when you believe that the price of the stock is going down. Be careful selling naked options because of the large risks associate with the trade.
What Is a Short Call?
- A short call is when an options writer doesn’t own the position represented by their options contract. A short call means you’re betting price will drop. A short call is another term for selling a call. When it comes to options trading, there are different names for the same strategy.
Seems like overkill right? Why have multiple names for the same strategy? While there’s no easy answer for that, our trading service makes sure to cover each name so you have the knowledge.
In order to understand a short call, let’s look at what options are. Options give you the right but not the obligation to buy or sell a stock at a set price within a certain time frame.
One contract controls 100 shares. As a result, you can trade the large cap stocks without putting up the capital it takes to own 100 shares. In fact, it’s a great way to grow a small account.
Many times people think penny stocks when they want to grow a small account. However, it’s a manipulated sector. Therefore, options are safer.
They do have more moving parts than stocks though. It’s important to be aware of that when trading them. Things like the Greeks and implied volatility affect your profit and loss.
Options also have strategies that make money in any market. A short call is no different. Whether the market is up, down or sideways, you can profit.
A Short Stock Position vs a Short Call Option
Is shorting a stock the same as a short call option? To understand that let’s look at what a call is. A call is the bullish side of options.
When you believe a stock is going to move up, you’d buy a call. However, a short call is different because you’re selling the call. As a result, you’re actually bearish on the trade.
What is a short stock position, and how does that differ from a short call? You take a short position on a stock or other instrument when you anticipate a short-term decrease in the asset’s value. To execute a short sell, you borrow the shares from your brokerage, sell them at the current price, and then buy them after the price drops. Then you return the shares you borrowed and profit from the difference between your sell and buy prices.
You still buy low and sell high; you merely do it in reverse with a security you don’t own. A short call is an options strategy.
How Short Selling Differs From Selling a Call
In the case of options, you aren’t outright buying or selling securities. Instead, you buy and sell derivatives based on those securities. An option is a contract of 100 shares between the writer (seller) and the holder (buyer) for a specific time frame.
Also, there are two components to options trading, puts and calls. You’re able to go long or short on either.
When trading options, the writer, the party who creates the contract, is obligated to sell or buy if the holder executes the contract. However, the holder has the right, but no obligation to sell or buy.
Additionally, the holder pays the writer a premium fee for this right. And the writer’s objective is to receive the premium without the holder executing the right to sell or buy.
As the writer, you want the contract to expire worthlessly. That’s why if you think the market is bearish, then you go bullish. Likewise, if you think the market is bullish, then you go bearish.
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Short Call Options Strategy
What is the difference between a long call and a short call? What is a long call, and how does it differ? Or what about a short put?
Let’s briefly cover the four basic options strategies before delving specifically into short calls.
The option writer has the obligation to buy the asset. On the other hand, the option holder has the right to sell the asset. The writer’s directional bias is bearish. Therefore, the value of the long put option increases as the price of the underlying asset drops.
The option writer has the obligation to sell the asset. n the other hand, the option holder has the right to buy the asset. The writer’s directional bias is bullish. As a result, the value of the long call option increases as the price of the underlying asset rises.
The option writer has the obligation to buy the asset. The option holder has the right to sell the asset. The writer’s directional bias is bullish. Therefore, the value of the short put option increases as the price of the underlying asset rises.
The option writer has the obligation to sell the asset. Therefore, the option holder has the right to buy the asset. The writer’s directional bias is bearish. As a result, the value of the short call option increases as the price of the underlying asset drops.
The highlighted section on NVDA shows a tweezer top pattern which is a bearish reversal right at the moving averages. Because you know it’s a bearish reversal you can take a short call position. The buyer would think it was going up but instead it heads down. If the contract expires worthless, you get to keep the premium they paid you .
Can We Have a Short Call?
- A short call means selling a call option where you’re obligated to buy the stock in the future at a fixed price.
- This limits profit if the stock trades below the strike price you bought.
- The risk is greater if price goes above the price above where the strike price was when the call was sold.
Shorting a Covered Call vs an Uncovered Call
Shorting an uncovered call, also known as a “naked call,” is a risky strategy. Theoretically, the risk is infinite because the price of the underlying asset could skyrocket.
The price of a falling asset can’t go below zero, but the price of a rising asset has no limit. Since the holder has no obligation to execute the option, the holder only risks the premium.
The writer, on the other hand, risks much more. If the price goes up, and the holder executes the right to buy, the writer must sell the shares.
For example, let’s say the writer shorted a naked call when the stock traded at $50 per share at a strike price of $55. Then the stock hits $70 when the holder executes the option.
Since the call was uncovered, which means the writer owned no shares of the underlying asset, the writer must purchase the shares at the current price and sell at the strike price.
In this case, the writer must buy 100 shares at $70 per share ($7,000) then sell them to the holder for $55 per share ($5,500). Note that this $1,500 loss pertains to one contract.
If the writer created more than one contract, then multiply the loss by the number of contracts. Also, take fees and commissions into account. Although the writer still keeps the premium.
Can your short call breakeven? The answer is, “Yes.” The BEP (break even point) occurs when the price of the underlying asset equals the strike price plus the amount of the premium. However, keep in mind the BEP doesn’t take the cost of commissions into account.
What Covers a Short Call?
Some traders limit losses by placing covered calls. In other words, they own the shares of the underlying security.
If the trade goes against them, then they don’t need to purchase the asset. They already own it.
They still must relinquish the 100 shares per contract, but they don’t need to purchase the stock at the higher price. For example, the writer may decide to use a long stock-short call strategy in a one-to-one ratio. In this case, the writer covers the call by going long on the stock and short on the call.
Another way traders limit loss is via advanced strategies, like wingspread strategies. They place puts and calls at low and high strike prices to help minimize the downside and upside risk.
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Short Call Calculator
To determine your short call option payoff, use the following payoff formula:
Payoff per share = (the premium per share minus MAX (0, share price of underlying asset minus the strike price))
MAX means that if the price of the underlying asset minus the strike price is positive rather than negative, then you use zero. In this case, you don’t profit when the price of the underlying asset goes up.
You only profit when the price falls. That’s why the MAX is zero if the price of the underlying asset is higher than the strike price. Then there is no payoff other than the premium.
It’s easier to use an options calculator. A calculator is available here.
Because options have more moving parts than stocks, it’s important to practice. Use the calculator while trading in a paper trading account.
That way you can work out the kinks and find the best possible trading strategy for you.
A short call is a bearish play. You sell the call when you believe price is going to fall. As a result, you want the contract to expire worthless. Because 80% of options expire worthless, the odds are incredibly in your favor.