Short Call Explained

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Short Call (Naked Call) Options Trading Strategy Explained

Published on Wednesday, April 18, 2020 | Modified on Wednesday, June 5, 2020

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Short Call (Naked Call) Options Strategy

Strategy Level Advance
Instruments Traded Call
Number of Positions 1
Market View Bearish
Risk Profile Unlimited
Reward Profile Limited
Breakeven Point Strike Price of Short Call + Premium Received

Short Call (or Naked Call) strategy involves the selling of the Call Options (or writing call option). In this strategy, a trader is Very Bearish in his market view and expects the price of the underlying asset to go down in near future. This strategy is highly risky with potential for unlimited losses and is generally preferred by experienced traders.

The strategy involves taking a single position of selling a Call Option of any type i.e. ITM or OTM. These naked calls are also known as Out-Of-The-Money Naked Call and In-The-Money Naked Call based on the type you choose. This strategy has limited rewards (max profit is premium received) and unlimited loss potential. When the trader goes short on call, the trader sells a call option and earn profits if the price of the underlying asset goes down. The trader receives the premium when he sells the call option. This premium is the maximum profit trader gets in case the price of underlying asset falls.

Let’s assume you are bearish on NIFTY and expects its price to fall. You can deploy a Short Call strategy by selling the Call Option of NIFTY. If the price of NIFTY shares falls, the call option will not be exercised by the buyer and you can retain the premium received. However, if the price of NIFTY rises, you will start losing money significantly and rapidly on every rise.

This strategy has unlimited risk and limited rewards.

How to use the short call options strategy?

The short call strategy looks like as below for NIFTY which is currently traded at в‚№10400 (NIFTY Spot Price):

ITM Naked Call Order – NIFTY

Orders NIFTY Strike Price
Sell 1 ITM Call NIFTY18APR10200CE

Suppose NIFTY shares are trading at 10400. If we are expecting the price of NIFTY to go down in near future, we sell 1 NIFTY Call Option to implement this strategy.

If NIFTY falls as we expected, the call options will not be exercised by buyer and we will keep the premium received at the time of selling the call option. This is also the maximum profit in this strategy.

If NIFTY rises, the losses are unlimited. This makes it extremely risky strategy. This strategy should be used very carefully with bracket orders (stop loss).

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When to use Short Call (Naked Call) strategy?

It is an aggressive strategy and involves huge risks. It should be used only in case where trader is certain about the bearish market view on the underlying.

Example

Example 1 – Stock Options (OTM Naked Call)

Let’s take a simple example of a stock trading at в‚№48 (spot price) in June. The option contracts for this stock are available at the premium of:

Lot size: 100 shares in 1 lot

  1. Sell July 50 Call = 100 * 3 = в‚№300 Premium Received

Net Credit: в‚№300

Now let’s discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at в‚№48

  • Sell July 50 Call: Expires Worthless
  • Net credit was в‚№300 which was received as premium initally.
  • Total profit = в‚№300 as we keep the premium.

The total profit of в‚№300 is also the maximum profit in this strategy. This is the amount you received as premium at the time you enter in the trade.

Scenario 2: Stock price goes up to в‚№68

  • Sell July 50 Call expires in-the-money with an intrinsic value of (50-68)*100 = -в‚№1800
  • Net credit was в‚№300 which was received as net premium.
  • Total Loss = -1800 + 300 (Premium Received) = -в‚№1500

In this scenario, we lost total в‚№1500. The loss could be significantly higher if the price of the stock keeps rising further.

Scenario 3: Stock price goes down to в‚№28

Same as scenario 1:

  • Sell July 50 Call: Expires Worthless
  • Net credit was в‚№300 which was received as premium initally.
  • Total proft = в‚№300 as we keep the premium.

Example 2 – Bank Nifty

Short Call Example Bank Nifty
Bank Nifty Spot Price 8900
Bank Nifty Lot Size 25
Short Call Options Strategy
Strike Price(в‚№) Premium(в‚№) Total Premium Paid(в‚№)
(Premium * lot size 25)
Sell 1 ITM Call 8800 500 12500
Net Premium 500 12500
Breakeven(в‚№) Strike price of the Short Call + Net Premium
(8800 + 500)
9300
Maximum Possible Loss (в‚№) Unlimited Unlimited
Maximum Possible Profit (в‚№) Net Premium Received * Lot Size
(500)*25
12500
On Expiry Bank NIFTY closes at Net Payoff from 1 ITM Call Sold (в‚№) @8800 Net Payoff (в‚№)
8800 0
(8800-8800)*25
12500
12500-0
9000 -5000
(8800-9000)*25
7500
12500-5000
9200 -10000
(8800-9200)*25
2500
12500-10000
9400 -15000
(8800-9400)*25
-2500
12500-15000
9600 -20000
(8800-9600)*25
-7500
12500-20000

Market View – Bearish

When you are expecting the price of the underlying or its volatility to only moderately increase.

Actions

  • Sell Call Option

Breakeven Point

Strike Price of Short Call + Premium Received

Break even is achieved when the price of the underlying is equal to total of strike price and premium received.

Risk Profile of Short Call (Naked Call)

Unlimited

There risk is unlimited and depend on how high the price of the underlying moves.

Reward Profile of Short Call (Naked Call)

Limited

The profit is limited to the premium received.

How can I tell the difference among long call, long put, short call and short put?

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This can easily get confusing. Always remember the following:

Long means buy
Short means sell

To be long a call means you are buying a call option. This is a bet that prices will rise.

To be short a call means you are selling a call option. This is a bet that prices may fall. Although, many people “write call options” (short calls) when they are long the underlying security in the hopes of profiting from low price volatility.

To be long a put means you a buying a put option. This is a bet that prices will fall.

To be short a put means that you are selling a put option. This is an in.

5.1. Короткая позиция по опциону колл

Еще раз обратимся к определению опциона колл, данному в третьей главе. Опцион колл дает владельцу право, но не обязательство, на покупку определенного количества акций (100 штук) по определенной цене (цена исполнения) при или до истечения определенного срока (дата истечения). Опционы колл — это не акции, потому что они не выпускаются корпорациями, а продаются в короткую (sold short), или выписываются (written), другими участниками рынка. Каждый раз, когда некто покупает опцион колл на акцию, торгуемую на рынке, кто-то другой его продает. На каждую длинную позицию существует короткая позиция. Что это такое — находиться в короткой позиции по колл опциону? Ключ к ответу в определении “право, но не обязательство”. Владелец (то есть сторона, которая купила опцион) имеет право, но не обязательство. Тот, кто находится в длинной позиции по опциону, имеет возможность выбора: купить ему акции или нет в день или до дня истечения срока. Решающий аспект опциона колл обеспечивает особенно изогнутый профиль цены при истечении срока, как это показано на Рисунке 3.1.

Теперь представьте ситуацию, когда вы находитесь в короткой позиции на такой опцион колл (с ценой исполнения $100). Если вы находитесь в короткой позиции на этот инструмент, то вами представлено право сделать выбор владельцу опциона: взять у вас акции по $100 или нет. Вы не можете повлиять на решение обладателя опциона, но можете предположить, что он предпримет. Если цена акции выше $100 к моменту истечения срока, то он даст заявку на покупку, согласно которой вам придется предоставить ему акции по $100 за штуку. Если у вас уже нет акций, то вам потребуется приобрести их. Если цена к этому времени значительно поднялась, то вы можете понести большие убытки. Скажем, цена акции при истечении срока равна $120, тогда заявка на покупку вынудит вас купить акции по $120 и продать их владельцу опциона по $100, в результате чего убыток составит $20 за акцию. Так как для цен акций не существует верхнего предела, то нахождение в короткой позиции на опцион колл может быть весьма опасным. На практике обычно совсем не обязательно покупать акции: намного проще выкупить обратно короткий опцион и понести те же убытки. Но что, если цена акции ниже $100 к моменту срока истечения? Понятно, что владелец не станет исполнять свое право на покупку акции по $100, так как на рынке они дешевле. В такой ситуации тот, кто был в короткой позиции на опцион, выкупит его на нулевом уровне. Это — наилучшая ситуация для непокрытых продавцов (naked writers) опционов колл. Термин “непокрытый”, или “голый”, здесь относится к опционам колл, которые никак не хеджируются. Непокрытые продавцы берут премии за продажу опциона и рассчитывают на обесценивание опциона к сроку истечения. Вспомните одногодичный опцион колл, о котором мы говорили в третьей и четвертой главах. При цене акции $99 и сроке в один год до истечения срока опцион оценивается в $5,46. Продавец непокрытого опциона колл, выписывая один опцион, получает опционную премию $546. Если инструмент истекает без денег или обесценен, то фактически продавец может выкупить опцион за $0 и получить прибыль в $546. Это максимум того, что продавец мог бы сделать, и эта ситуация для всех продавцов непокрытого опциона одинакова. В самом лучшем случае у них остается первоначальная премия, а в худшем варианте предела убыткам нет.

Продавцы опционов и покупатели опционов всегда находятся в противоположных ситуациях. Каждый доллар, зарабатываемый одной стороной, становится убытком другой стороны. Продавцы опционов имеют ограниченный потенциал прибыли и неограниченный потенциал убытков, в то время как покупатели опционов имеют ограниченный потенциал убытков и неограниченный потенциал прибыли. Поэтому при истечении срока профили прибылей и убытков в графическом смысле противоположны друг другу. Это означает, что все диаграммы коротких позиций на опцион являются зеркальным отображением длинных позиций. Рисунок 5.1 отражает “стоимость” рассматриваемого длинного и короткого опциона колл к сроку истечения.

Рисунок 5.1 (а) показывает стоимость длинного опциона колл, которая либо положительна, либо равна нулю, а Рисунок 5.1 (b) показывает стоимость короткого опциона колл в виде или отрицательной, или нулевой величины. При цене акции $120 длинный опцион стоит $2.000 ($20 за акцию). Это — сумма, которую владелец получает при закрытии (то есть продаже) своей длинной позиции. Итак, короткий опцион стоит $2.000, а это значит, что такую сумму продавец должен доплатить при закрытии (то есть обратной покупке) своей короткой позиции. Знак “минус” используется для того, чтобы показать, что при такой цене акции короткая позиция имеет долг величиной в $2.000. При большей цене акции долг по короткой позиции увеличивается, и об этом свидетельствует отрицательный наклон линии. Выше цены исполнения линия к истечению срока имеет наклон в $100. Для продавца опциона каждый подъем на $1 приводит к убытку в $ 100. Выше цены исполнения экспозиция составляет шорт 100 акций.

Long Call vs. Short Put Differences and When to Trade Which

This page explains differences between long call and short put option positions. Using an example, we will compare their cash flows and payoff profiles. We will conclude with recommendations when to trade which strategy.

What Long Call and Short Put Have in Common

Long call and short put are among the simplest option strategies, each involving just a single option. Both are bullish, which means they make money when the underlying security goes up and they lose when the underlying declines.

Therefore it might seem they are the same and it doesn’t matter which one you choose when you think a stock will go up.

It does. In fact, these two strategies differ in many ways, which we will illustrate on an example.

Example

Let’s say you think a stock, currently trading at $35 per share, might go up. You are deciding between:

  • buying a $35 strike call option and
  • selling a $35 strike put option.

Both options are currently trading at $2 per share, or $200 for one option contract (representing 100 shares of the underlying stock).

Initial Cash Flow

Long call position is created by buying a call option. To initiate the trade, you must pay the option premium – in our example $200.

Short put position is created by selling a put option. For that you receive the option premium.

Long call has negative initial cash flow. Short put has positive.

From this alone it would seem short put is a better trade than long call. Nevertheless, the advantage of cash flow goes hand in hand with numerous disadvantages, particularly a less favorable risk and return profile.

Maximum Possible Profit

What is the most you can possibly gain from each trade?

Long call makes money when underlying stock goes up. If the stock ends up above the strike price $35 at expiration, the call option’s value increases dollar for dollar with the stock. For example, if the stock ends up at $40, the call will be worth 40 – 35 = $5 at expiration. Net of initial cost, the long call trade will make $3 per share, or $300 for one contract. If the stock ends up at $50, the option’s value will be 50 – 35 = $15 and overall profit $13 per share, or $1,300 for one contract. The higher the stock, the higher the profit.

Short put is also profitable when the stock goes up, but the profit is limited to the $200 received for selling the put in the beginning. There is no way you can gain more, regardless of the stock going to $40, $50, or $500. You keep the option premium received, but that’s it.

Long call has unlimited potential profit. Short put has it limited to premium received (initial cash flow).

Maximum Possible Loss

If you are wrong and the stock price falls, how much can you lose in the worst case?

With long call, the worst case scenario is that the stock ends up below $35 and the option expires worthless. You will lose the option premium paid in the beginning, but nothing more. Maximum possible loss is $200.

A short put position is much riskier. The put option will increase in value as the stock falls. Because you are short the option, its value is your loss. For example, if the stock ends up at $30 at expiration, the put will be worth 35 – 30 = $5 and you will lose $500. With the $200 premium received in the beginning your overall loss will be $300.

Theoretically, in the worst case, the stock can fall to zero and the put option’s value will be equal to its strike price: $35 per share, or $3,500 for one contract. With premium received your overall loss will be $3,300.

Maximum risk of a long call trade is limited to initial cost (option premium paid). Maximum risk of a short put is typically very high and equal to strike price minus option premium received.

Long Call and Short Put Payoff Diagrams

The difference in profit and loss profile is easiest to understand when visualized in a payoff diagram. This is a chart that shows how an option strategy’s total profit or loss (Y-axis) changes with underlying price (X-axis).

The long call position loses $200 when underlying price ends up below the strike price at expiration. Beyond that point, the P/L rises proportionally to underlying price. There is no limit on the upside.

The short put position makes $200 when underlying price ends up above the strike. Below the strike, its P/L declines.

From the charts it might seem that long call is a much better trade than short put. Limited risk and unlimited profit looks certainly better than limited profit and (almost) unlimited risk. Is there a scenario when short put is actually better than long call?

When Short Put Beats Long Call

If you draw both payoffs in one chart, you will see there is a small window of stock prices where the short put’s outcome (red) is better than long call (green).

It is the area around the strike price. More precisely, in this particular example, the short put trade beats the long call trade when the underlying stock ends up between $31 and $39. At $31 both strategies lose $200. At $39 both gain $200.

The general formula for calculating the borders is strike price plus or minus the sum of the two option premiums (in our example 35 – 2 – 2 = 31 and 35 + 2 + 2 = 39).

Break-Even Point

In the chart above, notice where the P/L for each strategy crosses the zero line – this is where the trade starts to be profitable.

The break-even point for a long call position is above the strike price. More precisely, it is strike price plus option premium paid. The long call position in our example starts to be profitable with underlying stock at 35 + 2 = $37 at expiration.

For a short put, the break-even point is below the strike, exactly at strike price minus option premium received. In our example, the short put is profitable above 35 – 2 = $33.

This is a big advantage of short put. It is profitable even when the stock doesn’t move anywhere (it may even go down a little). A long call typically requires the stock to go up to make a profit.

When to Trade What

You can see that both long call and short put have strengths and weaknesses. Advantages of long call are smaller risk and unlimited profit potential. Benefits of short put include positive initial cash flow and lower break-even point (for the same strike).

In fact, the outcome of long call is better than short put if the underlying stock moves a lot – to either side. Conversely, if the stock doesn’t move much (in our example if it stays between $31 and $39), short put does better.

This is very common with options. Buying options (being “long volatility”) is generally better when the underlying moves a lot. Selling options (being “short volatility”) is generally better when it doesn’t move much.

To sum up, when deciding between a possible long call and short put trade, think more deeply about your expectations regarding the underlying stock price – not only in terms of direction, but also in terms of volatility:

  • If you think the stock could make a big move up, but at the same time you don’t want to lose too much if it falls, choose long call.
  • If you think the stock will probably increase only moderately, but it is unlikely to go down too much (it might as well trade in a range for a while), choose short put.

In practice, it gets more complicated than this. Your selection will also depend on how much volatility is currently being priced in the options. If you expect rangebound trading, but the option market expects it too and option premiums are low, selling a put may not be a good idea. This is slightly more advanced and requires good understanding of implied volatility and option pricing.

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