Call Writing
Instead of purchasing call options, one can also sell (write) them for a profit. Call option writers, also known as sellers, sell call options with the hope that they expire worthless so that they can pocket the premiums. Selling calls, or short call, involves more risk but can also be very profitable when done properly.
Naked (Uncovered) Calls :
When the option trader write calls without owning the obligated holding of the underlying security, he is shorting the calls naked. Naked short selling of calls is a highly risky option strategy and is not recommended for the novice trader.
The naked call write is a risky options trading strategy where the options trader sells calls against stock which he does not own. Also known as uncovered call writing.
The options trader must be careful in the selection of the strike price of the call to be written as it has a significant impact to the profit/loss potential of the trade.
If one is neutral to mildly bearish on the underlying, one would execute a premium collection strategy by writing out-of-the-money naked calls.
If one is bearish to very bearish, then one would write deep-in-the-money naked calls as an alternative to shorting the underlying stock.
Instead of purchasing call options, one can also sell (write) them for a profit. Call option writers, also known as sellers, sell call options with the hope that they expire worthless so that they can pocket the premiums. Selling calls, or short call, involves more risk but can also be very profitable when done properly.
Naked (Uncovered) Calls :
When the option trader write calls without owning the obligated holding of the underlying security, he is shorting the calls naked. Naked short selling of calls is a highly risky option strategy and is not recommended for the novice trader.
The naked call write is a risky options trading strategy where the options trader sells calls against stock which he does not own. Also known as uncovered call writing.
The options trader must be careful in the selection of the strike price of the call to be written as it has a significant impact to the profit/loss potential of the trade.
If one is neutral to mildly bearish on the underlying, one would execute a premium collection strategy by writing out-of-the-money naked calls.
If one is bearish to very bearish, then one would write deep-in-the-money naked calls as an alternative to shorting the underlying stock.
Call Writing/Naked Call Example :
Stock XYZ is trading at $47.89 per share DEC 50 Call is trading at $1.25 premium
Investor A forecasts that XYZ will not trade above $50 per share before December, so he sells the 10 DEC 50 Calls for $1,250 (each option contract controls 100 shares). Investor A doesn't buy the stock, therefore his investment is considered naked.
Meanwhile, Investor B forecasts that XYZ will go above $50, so he purchases those 10 calls from Investor A for $1,250. At expiration of the option, consider 4 different scenarios where the share price drops, stays the same, rises moderately or surges.
The following are four scenarios for the example:
Scenario 1 :
Stock drops to $43.25 DEC 50 Call expires worthless
Investor A keeps the entire premium of $1,250 Investor B makes a 100% loss
Scenario 2
Stock stays at $47.89 DEC 50 Call expires worthless
Investor A keeps the entire premium of $1,250 Investor B makes a 100% loss
Scenario 3
Stock rises to $52.45 DEC 50 Call is exercised
Investor A is forced to buy 1,000 shares of XYZ for $52,450 and immediately sell them at $50,000 for a loss of $2,450. Since he received the premium of $1,250 before, his net loss is $1,200. Investor B buys 1,000 shares of XYZ for $50,000 and now is able to sell them at open market for $52.45 per share if he chooses to. His net gain is $1,200 (same as Investor A's loss excluding commission costs)
Scenario 4
Stock surges to $75.00 on a news announcement DEC 50 Call is exercised
Investor A is forced to buy 1,000 shares of XYZ for $75,000 and immediately sell them at $50,000 for a loss of $25,000. Since he received the premium of $1,250 before, his net loss is $23,750 Investor B buys 1,000 shares of XYZ for $50,000 and now is able to sell them at open market for $75.00 per share if he chooses to. His net gain is $23,750 (same as Investor A's loss excluding commission costs)
