Short Call Strategy - Risks & How to Exit in Option Trading? | Espresso

What is Short Call Strategy in Online Option Trading?

A short call strategy is one of the simplest ways in which a trader can take a bearish position in the market. But with a short call strategy, the trader can make limited profits but is exposed to unlimited risks. So, this strategy is appropriate for seasoned traders who know the market and can understand the way the market moves.

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If you are new to trading and are curious about short call strategy in online option trading, then this article will help you.

What is Short Call Strategy?

A short call refers to selling a call option where you have a right to buy an underlying asset at a predetermined date at a prefixed price in the future. However, you are not obligated to exercise the option and buy the underlying asset by the expiration date.

This strategy has a limited potential for profits in case the stock is trading below the strike price but has a higher risk if the stock is trading over the strike price.

When Should Short Call Strategy be Initiated?

The best time to initiate a short call option strategy is when you are expecting that the value of the underlying asset will fall moderately. You will still be at an advantage if the value of the underlying asset stays unchanged. This is because the time decay element will always be favourable for you. After all, the time value of the call option will fall as the expiration date comes nearer.
Also Read: Best Time to Sell Stocks

The benefit of this strategy is that you will receive credit in advance, which might be helpful for you to offset the amount of margin. But, by taking such a position, you are exposing yourself to unlimited losses in case the price of the underlying asset rises dramatically.

Example of Short Call Strategy

NIFTY

9600

Sell ATM Call

9600

Received Premium

₹120

Break-Even Point

₹9720

Lot Size

75

Suppose that Nifty trades at ₹9600, and the call option that has a strike price of 9600 is currently trading at ₹120. If you are expecting the Nifty to fall slightly in the coming days, you can exercise the call option and sell at ₹9600 strike price. With this, you will get an upfront premium of ₹9000 (75 x ₹120). The transaction will help you in receiving net credit. If the option expires worthless, then this is the maximum amount of profit that you will make.

So, if the Nifty remains the same or falls below 9600, the options will expire worthless, and you will make a profit of ₹9000, and you will also not have any liability.

But, if the Nifty increases above the strike price, you will make losses.

Let us understand the payoff schedule according to diverse scenarios at the time of expiration. For this, the commission and margin amount has not been taken into account.

If at expiry the Nifty closes at

Net payoff (per stock)

9300

₹120

9400

₹120

9500

₹120

9600

₹120

9700

₹20

9720

₹0

9800

₹80 (loss)

9900

₹180 (loss)

10000

₹280 (loss)

What are the Risks and Rewards Involved in the Short Call Strategy?

The risks involved in this strategy are unlimited, so it is preferable to seasoned traders who are aware of the workings of the market. The rewards from the short call strategy are limited to the premium that you receive if the price of the underlying asset falls or remains the same.

How to Manage the Risks in Short Call Option Strategy?

Since you are exposed to unlimited risks in this strategy, holding an overnight position is not recommended. Also, you should follow the stop loss strictly so that you can limit the amount of loss that might occur.

Furthermore, ensure that you study the market diligently and make a proper decision based on your assessment of the market.

How to Exit the Short Call Strategy?

There are three ways in which you can exit this strategy:

  • You can wait for the expiry of the options so that you can retain the premium for yourself.
  • You can also buy a call option that has a lower strike price than the one which you already have.
  • You can also buy the call option back.
    Know more about Intraday Trading Strategies in Detail

Conclusion

A short call strategy can help you make profits if the trade goes according to your assumptions, but it is quite risky. Therefore, as a new investor, this strategy is not recommended for you. Also, this strategy might not be the best one if you are expecting the price of an underlying asset to fall in a short period.

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Frequently Asked Questions

The writer of the call option makes profits if the price at which the underlying stock trades remains below the strike price. But, the profit that you receive is limited to the premium that the writer receives for writing the call option.

Short call strategy exposes you to an unlimited risk of losses. But, if you know the market well and have an appropriate risk profile, this might be a good option for you.

The main advantage of this strategy is that you can benefit from the fall in the price of an underlying asset. On the contrary, as the price of the underlying asset increases, there is a chance of very high losses. Also, in this strategy, the profits are limited to the premium that you receive for writing the call option.

The break-even point in this strategy is achieved when the sum of the strike price and the premium that you have received is equal to the strike price of the underlying asset.

The short call option strategy comes into use when the trader feels that the market is bearish and he expects the price of the underlying asset to fall.