SHORT CALL
When
you buy a Call you are hoping that the underlying stock / index would rise.
When
you
expect the underlying stock / index to fall you do the opposite. When an
investor is
very
bearish about a stock / index and expects the prices to fall, he can sell Call
options.
This position
offers limited profit
potential and the
possibility of large
losses on big
advances
in underlying prices. Although easy to
execute it is a risky strategy since the
seller
of the Call is exposed to unlimited risk.
1.
A
Call option means an Option to buy. Buying a Call option means an investor
expects the underlying price of a stock / index to rise in future. Selling a
Call option is just the opposite of buying a Call option. Here the seller of
the option feels the underlying price of a stock / index is set to fall in the
future.
When to use: Investor is very aggressive and he is very bearish about
the stock / index.
Risk: Unlimited
Reward: Limited
to the amount of premium
Break-even Point: Strike Price
+ Premium
Example:
Mr. XYZ is
bearish about Nifty and expects it to fall. He sells a Call option with a
strike price of Rs. 2600 at a premium of Rs. 154, when the current Nifty is at
2694. If the Nifty stays at 2600 or below, the Call option will not be
exercised by the buyer of the Call and Mr. XYZ can retain the entire premium of
Rs. 154.
Strategy
: Sell Call Option
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Current Nifty index
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2694
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Call Option
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Strike Price (Rs.)
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2600
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Mr. XYZ receives
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Premium (Rs.)
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154
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Break Even Point (Rs.)
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2754
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(Strike Price +
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Premium)*
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2.
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The payoff chart (Short Call)
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The payoff schedule
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Net Payoff from
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On expiry
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the Call Options
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Nifty closes at
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(Rs.)
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2400
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154
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2500
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154
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2600
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154
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2700
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54
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2754
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0
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2800
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-46
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2900
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-146
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3000
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-246
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ANALYSIS: This strategy is used when an investor is very
aggressive and has a strong expectation of a price fall (and certainly
not a price rise). This is a risky strategy since as the stock price / index
rises, the short call loses money more and more quickly and losses can be
significant if the stock price / index falls below the strike price. Since the
investor does not own the underlying stock that he is shorting this strategy is
also called Short Naked Call.
