how a short call works
a short call strategy is one of two simple ways options traders can take bearish positions it involves selling call options or calls calls give the holder of the option the right to buy the underlying security at a specified price the strike price before the option contract expires the seller or writer of the call option receives the premium the buyer pays for the call the seller must deliver the underlying shares to the call buyer if the buyer exercises the option the success of the short call strategy rests on the option contract expiring worthless that way the trader banks the profit from the premium the expired position will be removed from their account for this to happen the price of the underlying security must fall below the strike price if it does the buyer won t exercise the option if the price rises the option will be exercised because the buyer can get the shares at the strike price and immediately sell them at the higher market price for a profit for the seller there s unlimited exposure during the length of time the option is viable that s because the underlying security s price could rise above the strike price during this time and keep rising the option would be exercised at some point before expiration once that happens the seller has to go into the market and buy the shares at the current price that price could potentially be much higher than the strike price that the buyer will be paying a seller of a call who doesn t already own the underlying shares of an option is selling a naked short call to limit losses some traders will exercise a short call while owning the underlying security this is known as a covered call or alternatively they may simply close out their naked short position accepting a loss that s less than what they d lose if the option were assigned exercised example of a short callsay that shares of humbucker holdings are trading near 100 and are in a strong uptrend however based on a combination of fundamental and technical analyses a trader believes that humbucker is overvalued they feel that eventually it will fall to 50 a share with that in mind the trader decides to sell a call with a strike price of 110 and a premium of 1 00 they receive a net premium credit of 100 1 00 x 100 shares the price of humbucker stock does indeed drop the calls expire worthless and unexercised the trader gets to enjoy the full amount of the premium as profit the strategy worked however things could instead go awry humbucker share prices could continue moving up rather than go down this creates a theoretically limitless risk for the call writer for example say the shares move up to 200 within a few months the call holder exercises the option and buys the shares at the 90 dollar strike price the shares must be delivered to the call holder the call writer enters the market buys 100 shares at the current market price of it turns out 200 per share this is the trader s result buy 100 shares at 200 per share 20 000receive 90 per share from buyer 9 000loss to trader is 20 000 9 000 11 000 trader applies 100 premium received for a total loss of 10 900 short calls can be extremely risky due to the potential for loss if they re exercised and the short call writer has to buy the shares that must be delivered short calls vs long putsas previously mentioned a short call strategy is one of two basic bearish strategies involving options the other is buying puts put options give the holder the right to sell a security at a certain price within a specific time frame going long on puts as traders say is also a bet that prices will fall but the strategy works differently say that our trader still believes humbucker stock is headed for a fall they opt to buy a put with a 90 strike price for a 1 00 premium the trader spends 100 for the right to sell shares at 90 even if the actual market price falls to 50 of course if the stock does not drop below 90 the trader will have lost the premium paid for the protection 