Article

Short Call Strategy Explained - Online Option Trading

25 Sep 2017 Nilesh Jain

Short Call Strategy:


What is Short Call strategy?

A Short Call means selling of a call option where you are obliged to buy the underlying asset at a fixed price in the future. This strategy has limited profit potential if the stock trades below the strike price sold and it is exposed to higher risk if the stock goes up above the strike price sold.

When to initiate a Short Call?

A Short Call is best used when you expect the underlying asset to fall moderately. It would still benefit if the underlying asset remains at the same level, because the time decay factor will always be in your favour as the time value of Call option will reduce over a period of time as you reach near to expiry. This is a good strategy to use because it gives you upfront credit, which will help you to somewhat offset the margin. But by initiating this position you are exposed to potentially unlimited losses if underlying assets goes dramatically high in price.

How to construct a Short Call?

A Short Call can be created by selling 1 ITM/ATM/OTM call of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Short Call Option

Market Outlook

Neutral to Bearish

Motive

Earn income from selling premium

Breakeven at expiry

Strike price + Premium received

Risk

Unlimited

Reward

Limited to premium received

Margin required

Yes

Probability

66.67%

Let’s try to understand with an Example:

NIFTY Current market Price

9600

Sell ATM Call (Strike Price)

9600

Premium Received

110

BEP (Rs.)

9710

Lot Size

75

Suppose Nifty is trading at Rs 9600. A Call option contract with a strike price of 9600 is trading at Rs 110. If you expect that the price of Nifty will fall marginally in the coming weeks, then you can sell 9600 strike and receive upfront premium of Rs 8,250 (110*75). This transaction will result in net credit because you will receive money in your broking account for writing the Call option. This will be the maximum amount that you will gain if the option expires worthless.

So, as per expectation, if Nifty falls or remains at 9600 by expiration, therefore the option will expire worthless. You will not have any further liability and amount of Rs 8,250 (110*75) will be your profit. The probability of making money is 66.67% as you can profit in two scenarios: 1) when price of underlying asset falls. 2) When price stays at same level.

Loss will only occur in one scenario i.e. when the underlying asset moves above the strike price sold.

Following is the payoff schedule assuming different scenarios of expiry. For the ease of understanding, we did not take into account commission charges and Margin.

On Expiry Nifty closes at

Net Payoff from Sell Buy (Rs.)

9300

110

9400

110

9500

110

9600

110

9700

10

9710

0

9800

-90

9900

-190

10000

-290

10100

-390

10200

-490

Payoff Diagram:

Impact of Options Greeks:

Delta: Short Call will have a negative Delta, which indicates any rise in price will have a negative impact on profitability.

Vega: Short Call has a negative Vega. Therefore, one should initiate Short Call when the volatility is high and expects it to decline.

Theta: Short Call will benefit from Theta if it moves steadily and expires at or below strike sold.

Gamma: This strategy will have a short Gamma position, which indicates any significant upside movement, will lead to unlimited loss.

How to manage Risk?

A Short Call is exposed to unlimited risk; it is advisable not to carry overnight positions. Also, one should always strictly adhere to Stop Loss in order to restrict losses.

Analysis:

A Short Call strategy can help in generating regular income in a falling or sideways market but it does carry significant risk and it is not suitable for beginner traders. It’s also not a good strategy to use if you expect underlying assets to fall quickly in a short period of time; instead one should try Long Put strategy.

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Short Call Strategy Explained - Online Option Trading

25 Sep 2017 Nilesh Jain

Short Call Strategy:


What is Short Call strategy?

A Short Call means selling of a call option where you are obliged to buy the underlying asset at a fixed price in the future. This strategy has limited profit potential if the stock trades below the strike price sold and it is exposed to higher risk if the stock goes up above the strike price sold.

When to initiate a Short Call?

A Short Call is best used when you expect the underlying asset to fall moderately. It would still benefit if the underlying asset remains at the same level, because the time decay factor will always be in your favour as the time value of Call option will reduce over a period of time as you reach near to expiry. This is a good strategy to use because it gives you upfront credit, which will help you to somewhat offset the margin. But by initiating this position you are exposed to potentially unlimited losses if underlying assets goes dramatically high in price.

How to construct a Short Call?

A Short Call can be created by selling 1 ITM/ATM/OTM call of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Short Call Option

Market Outlook

Neutral to Bearish

Motive

Earn income from selling premium

Breakeven at expiry

Strike price + Premium received

Risk

Unlimited

Reward

Limited to premium received

Margin required

Yes

Probability

66.67%

Let’s try to understand with an Example:

NIFTY Current market Price

9600

Sell ATM Call (Strike Price)

9600

Premium Received

110

BEP (Rs.)

9710

Lot Size

75

Suppose Nifty is trading at Rs 9600. A Call option contract with a strike price of 9600 is trading at Rs 110. If you expect that the price of Nifty will fall marginally in the coming weeks, then you can sell 9600 strike and receive upfront premium of Rs 8,250 (110*75). This transaction will result in net credit because you will receive money in your broking account for writing the Call option. This will be the maximum amount that you will gain if the option expires worthless.

So, as per expectation, if Nifty falls or remains at 9600 by expiration, therefore the option will expire worthless. You will not have any further liability and amount of Rs 8,250 (110*75) will be your profit. The probability of making money is 66.67% as you can profit in two scenarios: 1) when price of underlying asset falls. 2) When price stays at same level.

Loss will only occur in one scenario i.e. when the underlying asset moves above the strike price sold.

Following is the payoff schedule assuming different scenarios of expiry. For the ease of understanding, we did not take into account commission charges and Margin.

On Expiry Nifty closes at

Net Payoff from Sell Buy (Rs.)

9300

110

9400

110

9500

110

9600

110

9700

10

9710

0

9800

-90

9900

-190

10000

-290

10100

-390

10200

-490

Payoff Diagram:

Impact of Options Greeks:

Delta: Short Call will have a negative Delta, which indicates any rise in price will have a negative impact on profitability.

Vega: Short Call has a negative Vega. Therefore, one should initiate Short Call when the volatility is high and expects it to decline.

Theta: Short Call will benefit from Theta if it moves steadily and expires at or below strike sold.

Gamma: This strategy will have a short Gamma position, which indicates any significant upside movement, will lead to unlimited loss.

How to manage Risk?

A Short Call is exposed to unlimited risk; it is advisable not to carry overnight positions. Also, one should always strictly adhere to Stop Loss in order to restrict losses.

Analysis:

A Short Call strategy can help in generating regular income in a falling or sideways market but it does carry significant risk and it is not suitable for beginner traders. It’s also not a good strategy to use if you expect underlying assets to fall quickly in a short period of time; instead one should try Long Put strategy.