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 the stock price is decreasing. Be careful selling naked options because of the large risks associated with the trade.
A short call is when an options writer doesn’t own the position represented by their options contract. You’re betting the price will drop. A short call is another term for selling a call. Regarding 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, we’ll break them down for you.
What Does Short a Call Mean?
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 large-cap stocks without putting up the capital it takes to own 100 shares. It’s a great way to grow a small account.
People often think of 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. You can profit whether the market is up, down, or sideways.
Short Call vs Stock 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.
You’d buy a call when you believe a stock will move up. However, a short call is different because you’re selling the call. As a result, you’re bearish on the trade.
What is a short stock position, and how does that differ from a short call? When you anticipate a short-term asset value decrease, you take a short position on a stock or other instrument. To execute a short sale, 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 selling and buying prices.
You still buy low and sell high; you do it in reverse with a security you don’t own. A short call is an options strategy.
Short Selling vs 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.
The holder pays the writer a premium fee for this right. 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 you go bullish if you think the market is bearish. Likewise, if you think the market is bullish, you go bearish.
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?
Long Put
The option writer must 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.
Long Call
The option writer must sell the asset. On the other hand, the option holder has the right to buy the asset. The writer’s directional bias is bullish, and the value of the long call option increases as the underlying asset’s price rises.
Short Put
The option writer must buy the asset. The option holder has the right to sell the asset. The writer’s directional bias is bullish. Therefore, the short put option’s value increases as the underlying asset’s price rises.
Short Call
The option writer must 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 short call option’s value increases as the underlying asset’s price drops.
The highlighted section on NVDA shows a tweezer top pattern, a bearish reversal right at the moving averages. You can take a short call position because you know it’s a bearish reversal. The buyer would think it was going up, but heads down instead. If the contract expires worthless, you must keep the premium they paid you.
Shorting a Covered vs Uncovered Call
Shorting an uncovered call, also known as a “naked call,” is risky. Theoretically, the risk is infinite because the underlying asset’s price could skyrocket.
The price of a falling asset cannot be 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 increases and the holder exercises the right to buy, the writer must sell the shares.
For example, let the writer sell 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 exercises 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) and 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 multiple contracts, 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 break even? The answer is “Yes.” The “break-even point (BEP) occurs when the underlying asset equals the strike price plus the premium amount. However, remember that the BEP doesn’t consider the cost of commissions.
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, 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 a higher price. For example, the writer may 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 losses 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.
The 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 underlying asset’s price minus the strike price is positive rather than negative, you use zero. In this case, you don’t profit when the underlying asset’s price goes up.
You only profit when the price falls. The MAX is zero if the underlying asset’s price exceeds 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.
It’s important to practice because options have more moving parts than stocks. Use the calculator while trading in a paper trading account.
That way, you can work out the kinks and find the best trading strategy.
Final Thoughts: Short Call
A short call is a bearish play. You sell the call when you believe the 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.
Frequently Asked Questions
- 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 the price goes above the strike price when the call was sold
A short call means you are bearish and going short on the stock. A long call means that you are bullish and going long the stock.
Short call option example:
- Short call option with a strike price of $100
- Sold for $5.00
- The maximum profit potential $500
