The sale of a call option is classified as Short Call and is one of the four basic option strategies. A short call can be used as Naked Call be used for speculative purposes, or in combination with a long position in the underlying, as a Covered Call.
In this article you will learn what a short call is, how it can be used and what to look out for.
Definition Short Call
The term "short call" refers to the sale of a Call option (call option). The option seller receives a premium from the option buyer and in return undertakes to sell the underlying to the option buyer on a certain date (European type option) or by a certain date (American type option) at a certain price (strike price) if the option buyer exercises his right to purchase the underlying.
P&L diagram of a short call
As you can see in the P&L diagram, the short call has a limited profit potential (Option premium) with a simultaneously (theoretically) unlimited loss potential.
Possible applications
If a short call is used for purely speculative purposes and is not combined with other options or positions in the underlying, it is referred to as a "Naked Call". This is a kind of bet that the underlying will not be quoted above the strike price of the option on the expiration date.
The so-called "covered call" (covered call option) is also widespread. In this case, the option seller holds a long position in the underlying, which means that there is no longer any unlimited loss potential. If the underlying is quoted in The Money on the expiration date, only the long position in the underlying is liquidated.
What should I pay attention to when trading a short call?
The short call has a undefined loss potentialTherefore, a strict risk and money management is necessary. The unlimited loss potential can at best be limited by buying another call option with a higher strike price. The maximum profit is limited to the option premium collected.
Maximum and realized loss
The Maximum loss of a short call cannot be calculated, as the price of the underlying can theoretically rise indefinitely. If the underlying is quoted in the money at the expiration date or at the time the option is exercised, the actual loss can be calculated by calculating the difference between the price of the underlying and the strike price of the option and subtracting from this the option premium (credit) collected.
Loss = (price underlying - strike price option) - credit
After opening a short call position, the sold option can be bought back at any time in order to limit a resulting loss at an early stage. The unlimited loss potential can also be limited by simultaneously buying a call option with a higher strike price when opening the trade. (This creates a vertical call spread or a bear call spread).
Maximum profit
The maximum possible profit of a short call is limited to the amount of the Option premium limited. If the option expires Out Of The Money or At The Money, the maximum profit can be realized. However, option traders often buy back the option before the expiration date even if the trade develops positively in order to realize a profit.
Break Even Point
The strike price of the option is the price level from which an option is in-the-money or out-of-the-money and, accordingly, the price level from which a loss or profit occurs (on the expiration date). Since a premium is collected when an option is sold, it serves as a kind of buffer. The break-even point of a short call can thus be calculated by taking the Option price added to the strike price will.
Break Even Point = Strike Price Call + Credit
Choice of the base price
The further the strike price of the short call is from the current market price when the trade is opened, the lower is the Delta of the option and the more likely it is that the option sold will expire worthless and a profit will be made.
However, for an option that is far out of the money, the option price or premium is also significantly lower than for an option that is closer to the money.
Market assessment
The short call is a bearish to neutral strategy. It is speculated that the underlying is quoted below the strike price of the sold option on the expiration date. Since the strategy is usually implemented with out-of-the-money options, a profit can also be made if the underlying moves sideways or slightly upwards.
Implied volatility
The higher the implied volatility (IV) of an option, the higher the option price. The sale of call options therefore makes sense especially after a Increase in IV Sense. If the IV approaches its mean value again, the short call benefits from this.
Residual term and fair value expiry
Like all option strategies, the short call also benefits from the Time value loss of the options. The longer the remaining term of an option, the higher the option price. However, for options with a very long remaining term, the loss of time value has less of an effect than for options with a shorter remaining term.
Exercise of option on expiry date
If the short call expires in the money, the option is exercised. If you hold an ITM short call over the expiration date, this means that the underlying is booked short in the securities account or, if you hold a long position in the underlying (covered call), the position is closed out.