When the price of a stock rises, the value of a call option increases. They are the most well-known type of option, and they let you lock in a price to buy a specific stock by a certain date. Call options are appealing because they can appreciate quickly if the stock price rises a little. As a result of this, they are popular with traders seeking a large profit.
Selling Call Options
Call option sellers, sometimes referred to as writers, sell call options in the hopes that they will expire worthlessly. They profit by pocketing the premiums (price) they are paid. If the option buyer exercises their own option profitably while the underlying security price increases over the option strike price, their profit will be diminished, and they may even lose money.
Selling Call Options Explained
Call options can be purchased in two ways:
1) The Covered Call
If the call option seller owns the underlying stock, the call option is covered. Selling call options on these underlying stocks generates additional money and offsets any predicted stock price decreases. The option seller is "protected" from a loss because if the option buyer exercises their option, the seller can furnish the buyer with shares of the stock that he has previously purchased at a lower price than the option's strike price. The seller's profit from owning the underlying stock is restricted to the stock's rise to the option strike price, but he is protected from any actual loss.
2) The Naked Call
When the option seller sells the call option without owning the underlying stock, it is known as a naked call option. Since there is no limit on how high a stock's price could go and the option seller is not protected against potential losses by holding the underlying stock, naked short selling of options is regarded as exceedingly dangerous.
When the call option buyer exercises his right, the naked option seller is required to purchase the stock at market price and deliver the shares to the option holder. If the stock price exceeds the strike price of the call option, the seller will lose the difference between the spot market price and the strike price of it. To compensate for potential losses that may arise, most option sellers charge a high cost.
What is the Reason for Selling a Call Option?
There is a call sold for every call purchased. So, what are the benefits of selling a call option? In other words - the payout structure for buying a call is exactly the opposite. Call sellers predict the stock to stay flat or fall, and they want to collect the premium without risk.
Example of Selling Call Options
For instance, there is a stock ABC trading at 1,000 per share. You could sell a call on that stock with a 1,000 strike price for 200 with expiration in eight months. One contract would give you 20,000 (this is 200*1 contract*100 shares).
The payoff for the buyer would be exactly the opposite:
- For each price below the strike price of 1,000, the option will expire completely worthless, and the call seller would get to keep the cash premium of 20,000.
- Between 1,000 and 1,200 - the call seller still earns some of the premium but not all of it.
- Above 1,200 for a share, the call seller would begin to lose money beyond the 20,000 premium that has been received.
Selling calls has the advantage of receiving a cash premium upfront and not having to put money down right away. Then you wait till the stock is about to expire. You will profit if the stock drops, stays flat, or even climbs a little. However - unlike the call buyer, you would not be able to quadruple your money. The most you will make as a call vendor is the premium.
While selling a call may appear to be a low-risk strategy – and it often is – it can be one of the riskiest options strategies due to the possibility of limitless losses if the stock climbs.
The Benefit of Selling a Call Option
Selling call options, like most types of investing, has both gains and downside. Earning additional (premium) income on the stock you currently own or stock you don't own is one of the benefits. You could sell a one-month covered call 12 times in a year if you repeat this action. Finally, the premium you receive is paid in advance and remains yours regardless of what happens.
Risk of Selling a Call Option
On the negative side, premiums are limited, which limits profit potential. You can miss out on a huge upward movement in the underlying stock because you can't sell it without buying back the contract. Worst of all, your losses could be limitless depending on the sort of call option you sell.
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FAQs
Selling calls has the advantage of receiving a cash premium upfront and not having to put money down right away. Then you wait till the stock is about to expire. You will profit if the stock drops, stays flat, or even climbs a little. However - unlike the call buyer, you would not be able to quadruple your money.
What are the risks of selling a call option? ›
As a call seller, the most you'll make is the premium. While selling a call seems like it's low risk – and it often is – it can be one of the most dangerous options strategies because of the potential for uncapped losses if the stock soars.
What is the best strategy for selling call options? ›
A covered call is a basic options strategy that involves selling a call option (or “going short” as the pros call it) for every 100 shares of the underlying stock that you own. It's a relatively simple options trade to set up, and it generates some income from a stock position.
What are the rules for selling a call option? ›
Selling a call option
Call sellers (writers) have an obligation to sell the underlying stock at the strike price and have a “short call position.” The call seller must have one of these three things: the stock, enough cash to buy the stock, or the margin capacity to deliver the stock to the call buyer.
What is the most you can lose in selling a call option? ›
As a call seller your maximum loss is unlimited. To reach breakeven point, the price of the option should increase to cover the strike price in addition to premium already paid. Your maximum gain as a call seller is the premium already received.
What are the benefits of selling a call option? ›
Selling calls has the advantage of receiving a cash premium upfront and not having to put money down right away. Then you wait till the stock is about to expire. You will profit if the stock drops, stays flat, or even climbs a little. However - unlike the call buyer, you would not be able to quadruple your money.
What is the downside to selling calls? ›
Usually, selling covered calls would be a risky endeavor. This is because it exposes the seller to unlimited losses if the stock price soars. On the other hand, by owning the underlying stock, you can limit those potential losses and even generate income.
Which option selling strategy is most profitable? ›
A Bull Call Spread is made by purchasing one call option and concurrently selling another call option with a lower cost and a higher strike price, both of which have the same expiration date. Furthermore, this is considered the best option selling strategy.
What is the most profitable call option? ›
1. Selling Covered Calls – The Best Options Trading Strategy Overall. The What: Selling a covered call obligates you to sell 100 shares of the stock at the designated strike price on or before the expiration date. For taking on this obligation, you will be paid a premium.
Can you make money selling call options? ›
A call option writer stands to make a profit if the underlying stock stays below the strike price. After writing a put option, the trader profits if the price stays above the strike price. An option writer's profitability is limited to the premium they receive for writing the option (which is the option buyer's cost).
WHEN TO CLOSE A LONG CALL OPTION. Buyers of long calls can sell them at any time before expiration for a profit or loss, but ideally the trade is closed for a profit when the value of the call exceeds the entry price for purchasing it.
How to sell call options without buying? ›
Call options are sold in the following two ways:
- Covered Call Option. A call option is covered if the seller of the call option actually owns the underlying stock. ...
- Naked Call Option. A naked call option is when an option seller sells a call option without owning the underlying stock.
There are three traditional ways of exiting an options position. Exercise the position, allow the position to expire worthless, or offset it. Most traders choose the later and reverse the order to close, just like they traditionally do with stocks.
What is the risk of selling a call option? ›
Selling a call option has the potential risk of the stock rising indefinitely. When selling a put, however, the risk comes with the stock falling, meaning that the put seller receives the premium and is obligated to buy the stock if its price falls below the put's strike price.
How do you avoid loss in option selling? ›
The option sellers stand a greater risk of losses when there is heavy movement in the market. So, if you have sold options, then always try to hedge your position to avoid such losses. For example, if you have sold at the money calls/puts, then try to buy far out of the money calls/puts to hedge your position.
Can you lose money selling calls? ›
But if the stock drops more than the premium received from selling the call option, the covered call strategy begins to lose money. In fact, the covered call's maximum possible loss is the price at which the stock was purchased minus the credit(s) from the short calls plus transaction fees.
Can you lose money selling options? ›
As an options holder, you risk the entire amount of the premium you pay. But as an options writer, you take on a much higher level of risk. For example, if you write an uncovered call, you face unlimited potential loss, since there is no cap on how high a stock price can rise.
Why is selling put options risky? ›
Risks of Selling Puts
The profit on a short put is limited to the premium received, but the risk can be significant. When writing a put, the writer is required to buy the underlying at the strike price. If the price of the underlying falls below the strike price, the put writer could face a significant loss.
What is risk in option selling? ›
You must remember that writing/selling options in the Indian market, or anywhere else in the world, entails unlimited risk if the price movement is against you. For example, if you sell an Rs. 200 call at Rs. 5 and the price goes to Rs. 300, then you effectively lose Rs.
Are call options high risk? ›
Call options and put options essentially come with the same degree of risk. Depending on which "side" of the contract the investor is on, risk can range from a small prepaid amount of the premium to unlimited losses.
