A short call option
, also known as a naked call or simply a short call, is a financial derivative
strategy that involves selling call options on an underlying asset
that the option writer does not own. This strategy grants the option writer the obligation to sell the underlying asset at a predetermined price, known as the strike price
, to the option holder if the option is exercised before its expiration date.
When an investor
sells a call option, they receive a premium from the buyer of the option. In return, they take on the potential risk
of having to deliver the underlying asset at the strike price if the option is exercised. The seller of the short call option hopes that the price of the underlying asset will not rise above the strike price before the option expires, allowing them to keep the premium as profit
without having to deliver the asset.
Short call options are typically used by traders who have a neutral or bearish outlook on the underlying asset. By selling call options, they can generate income from the premiums received, especially in situations where they believe the price of the underlying asset will remain below the strike price. However, it is important to note that short call options come with unlimited risk.
If the price of the underlying asset rises above the strike price, the short call option becomes "in-the-money," meaning it has intrinsic value
. In this case, the option holder may exercise their right to buy the asset at the strike price, forcing the option writer to sell it to them. As a result, the option writer may be required to purchase the asset at a higher market price
and sell it at a lower strike price, resulting in a loss.
To limit their potential losses, traders who engage in short call options may choose to implement risk management strategies such as buying back the call option or using other options strategies like spreads or collars. These strategies can help mitigate the risk of unlimited losses associated with short call positions.
It is crucial for investors to thoroughly understand the risks involved in short call options before implementing this strategy. The potential for unlimited losses means that careful consideration of market conditions, underlying asset volatility
, and risk tolerance
is necessary. Additionally, it is important to have a clear plan in place for managing and exiting short call positions in order to protect against adverse market movements.
In summary, a short call option is a strategy where an investor sells call options on an underlying asset they do not own, with the expectation that the price of the asset will not rise above the strike price before the option expires. While this strategy can generate income through premium collection, it carries the risk of unlimited losses if the price of the underlying asset rises significantly. Traders must exercise caution and implement appropriate risk management strategies when engaging in short call options.