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Options Trading Strategies
Short Call
Writing Call Option
A trader shorts or writes a Call Option when he feels that underlying
stock price is likely to go down. Selling Call Option is a strategy preferred
for experienced traders.
We can use a Short Call Strategy when we are bearish in the market or a
particular type of underlying and we expect the prices to fall. In this
strategy we sell the Call in the assumption that the underlying will come down
sharply. This position offers limited profit potential and the possibility of
unlimited losses in case the rates of the underlying increases significantly.
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Though the strategy is very simple and easy to understand, execute and
profitable, please remember that this strategy has unlimited risk compared to
very limited profits.
We use this strategy when we highly expect a fall in the price of the
underlying. But his is a risky strategy as our profits are extremely but the
losses are unlimited as we tend to lose a lot of money if the underlying index
or stock keeps moving up.
Therefore this strategy should either be used when we are certain that
the underlying will go down or with a stop loss.
However this strategy is very risky in nature. If the stock rallies on
the upside, your risk becomes potentially unquantifiable and unlimited. If the
strategy works out in your favor then you will pocket the premium amount as
your reward.
Benefits of using the strategy
Benefits of using the strategy is Limited profits. Maximum profit will
be the premium at the time of writing (selling) the call.
Break even
The break-even point for us will be Strike Price + Premium.
Risk
There risk is unlimited and depend on how high the price of the
underlying moves.
Reward
The profit is limited to the premium
received.
Short Call Example
Just to refresh your memory, here’s a look at the profit and loss (PnL) diagram of a short call option contract.
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| Image by - sensibull.com |
If the NIFTY is trading around 11140 levels, Mr. X feels that Nifty is
likely to fall in the near future then he will sell one 11150 Call Option for a
premium of Rs. 191.90. Mr. X will get a credit of Rs 14,392.50 (191.90*75) in
his account for selling or writing the call option.
Breakeven: The break-even point for us will be 11,341.90
(11150+191.90).
Case 1: NIFTY closes at 11000 levels, Mr. X will bag the
premium amount i.e. Rs. 14,392.50. (191.90*75).
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| Image by - sensibull.com |
Case 2: NIFTY closes at 11500 levels; Mr. X will incur a loss of Rs. 11,857.50. [(11500-11150)-191.90)*75].
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