Home > Articles > Business & Management > Finance & Investing

This chapter is from the book

1.2 Short (Naked) Call

Proficiency

Direction

Volatility

Asset Legs

Max Risk

Max Reward

Strategy Type

49_01.jpg

49_02.jpg

N/A

49_03.jpg

49_04.jpg

49_05.jpg

49_06.jpg

Advanced

Bearish

 

Short Call

Uncapped

Capped

Income

1.2.1 Description

Although simple to execute, shorting a call (without any form of cover) is a risky strategy, hence its categorization as an advanced strategy. A short call exposes you to uncapped risk if the stock rises meteorically, and brokers will only allow experienced options traders to trade the strategy in the first place.

A call is an option to buy, so it stands to reason that when you buy a call, you’re hoping that the underlying share price will rise. If you’re selling or shorting a call, it’s therefore logical that you’d want the stock to do the opposite—fall.

050fig01.jpg

Steps to Trading a Short Call

  1. Sell the call option with a strike price higher than the current stock price.

    • Remember that for option contracts in the U.S., one contract is for 100 shares. So when you see a price of 1.00 for a call, you will receive $100 for one contract.

    Steps In

    • Try to ensure that the stock is rangebound or trending downward, and is below a clearly identifiable area of resistance.

    Steps Out

    • Manage your position according to the rules defined in your trading plan.
    • Hopefully the stock will decline or remain static, allowing your sold option to expire worthless so you can keep the entire premium.
    • If the stock rises above your stop loss, then exit the position by buying back the calls.
    • Time decay will be eroding the value of your call every day, so all other things being equal, the call you sold will be declining in value every day, allowing you to buy it back for less than you bought it for, unless the underlying stock has risen of course.

1.2.2 Context

Outlook

  • Bearish—You are expecting a fall in the stock price; you are certainly not expecting a rise in the stock.

Rationale

  • To pick up short-term premium income as the stock develops price weakness.

Net Position

  • This is a net credit transaction because you are receiving a premium for the call.
  • Your maximum risk is uncapped.
  • Your maximum reward is capped to the price you receive for the call.

Effect of Time Decay

  • Time decay is helpful to your naked sold option, so take advantage of the maximum time erosion. Maximum time decay (or theta decay) occurs in the last month before the option’s expiration, so it makes sense to sell one-month-or-less options only.
  • Don’t be fooled by the false economy that selling longer options would be more lucrative. Compare a one-month option to a 12-month option and multiply the shorter option price by 12. You will see that you are receiving far more per month for the one-month option. Also remember that you want the person on the long side of this trade to have as short a time as possible to be right.
  • Give yourself as little time as possible to be wrong because your maximum risk is uncapped.

Appropriate Time Period to Trade

  • One month or less.

Selecting the Stock

  • Ideally, look for stocks where the OVI is persistently negative for at least the last few days.
  • Choose from stocks with adequate liquidity, preferably over 500,000 Average Daily Volume (ADV).
  • The stock should be rangebound or trending downward, and below a clearly identifiable area of resistance.

Selecting the Options

  • Choose options with adequate liquidity; open interest should be at least 100, preferably 500.
  • Strike—Look for OTM strikes above the current stock price.
  • Expiration—Give yourself as little time as possible to be wrong. Remember that your short position exposes you to uncapped risk, and that time decay accelerates exponentially (in your favor when you’re short) in the last month before expiration, so only short the option with a maximum of one month to expiration, preferably less.

1.2.3 Risk Profile

Maximum Risk

[Uncapped]

Maximum Reward

[Call premium]

Breakeven

[Call strike + call premium]

1.2.4 Greeks

1.2.5 Advantages and Disadvantages

Advantages

  • If done correctly, you can profit from falling or rangebound stocks in this way.
  • This is another type of income strategy.

Disadvantages

  • Uncapped risk potential if the stock rises.
  • A risky strategy that is difficult to recommend on its own.

1.2.6 Exiting the Trade

Exiting the Position

  • Buy back the options you sold or wait for the sold option to expire worthless (if the underlying stock falls and stays below the strike price) so that you can keep the entire premium.

Mitigating a Loss

  • Use the underlying asset or stock to determine where your stop loss should be placed.

1.2.7 Margin Collateral

  • The minimum requirement specified by the CBOE is 100% of the option proceeds, plus 10% of the share value. Many brokers specify 100% of the option proceeds, plus 20% of the share value.

1.2.8 Example

  • ABCD is trading at $28.20 on February 19, 2015.
  • Sell the March 2015 30.00 strike call for 0.90.

You Receive

Call premium

0.90

Maximum Risk

Uncapped

Maximum Reward

Call premium

0.90

Breakeven

Strike price + call premium

30.00 + 0.90 = 30.90

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.

Overview


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information


To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.

Surveys

Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.

Newsletters

If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information


Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.

Security


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.

Children


This site is not directed to children under the age of 13.

Marketing


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information


If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.

Choice/Opt-out


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information


Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents


California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure


Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.

Links


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact


Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice


We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020