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What Is Short Call?
A short call involves selling a call option without owning the underlying asset. The seller receives a premium for the option but faces the risk of potential losses if the price of the underlying asset rises significantly.
The seller of a short call hopes the price of the underlying asset stays below the strike price. If the price remains below the strike price, the option expires worthless, and the seller keeps the premium as profit without any further obligation.
However, if the asset’s price rises above the strike price, the seller incurs potentially unlimited losses. In such a scenario, they would need to buy the asset at the market price to sell it at the lower strike price, leading to a loss.
What Is Covered Call?
A covered call is a strategy where an investor holds a long position in an asset and sells a call option on that same asset. The goal is to earn premium income while maintaining ownership of the asset.
The call option provides the investor with income through the premium received. If the asset’s price stays below the strike price, the option expires worthless, and the investor keeps both the asset and the premium, enhancing overall returns.
However, if the asset’s price rises above the strike price, the investor may have to sell the asset at the predetermined price, potentially limiting profit. The strategy works best in a stable or slightly bullish market.
Short Call Vs Covered Call
The main difference between a short call and a covered call is that a short call involves selling an option without owning the underlying asset, while a covered call involves holding the asset and selling a call option on it.
| Feature | Short Call | Covered Call |
| Ownership | The seller does not own the underlying asset. | The investor owns the underlying asset. |
| Risk | The risk is potentially unlimited if the asset price rises. | The risk is limited to the loss in the underlying asset. |
| Profit Potential | Profit is limited to the premium received. | Profit is limited by the strike price of the call. |
| Strategy Goal | Typically used in a bearish market. | Used in a neutral to slightly bullish market. |
How To Trade Short Call?
To trade a short call, follow these steps:
- Choose a Stock or Asset: Select a stock or asset that you believe will not rise significantly in price. This strategy benefits from the stock staying below the strike price.
- Select Strike Price and Expiration Date: Choose a strike price above the current stock price, where you expect the price to remain. Set the expiration date, typically 30–60 days away.
- Sell the Call Option: Sell a call option at the selected strike price. In exchange, you receive a premium. This gives the buyer the right, but not the obligation, to buy the underlying asset from you at the strike price.
- Monitor the Position: Track the stock’s movement. If the stock price stays below the strike price, the option expires worthless, and you keep the premium. If the stock price rises above the strike price, you may have to sell the stock at that price.
- Close the Position (Optional): If the stock is approaching or moving above the strike price, you can buy back the call option to limit losses, as the premium received might not be enough to cover potential losses.
- Be Prepared for Unlimited Risk: A short call has unlimited risk potential if the stock rises significantly, as there is no cap on how high the price can go. Therefore, it’s important to monitor the position closely.
How To Trade Covered Call?
To trade a covered call, follow these steps:
- Own the Underlying Asset: Buy shares of a stock that you want to trade the covered call on. This ensures you are holding the underlying asset, which is essential for the strategy.
- Select the Strike Price and Expiration Date: Choose a strike price above the current stock price where you believe the stock will not exceed by the expiration date. Set the expiration date, usually 30–60 days out.
- Sell the Call Option: Sell a call option with the selected strike price and expiration date. In exchange, you will receive a premium for the call option you sold.
- Monitor the Position: Track the stock’s price. If the stock stays below the strike price, the option expires worthless, and you keep the premium. If the stock rises above the strike price, you may have to sell your shares at the strike price.
- Close the Position (Optional): If the stock price is moving toward the strike price before expiration, you can close the position by buying back the call option to avoid assignment.
- Repeat the Process: If the call option expires worthless, you can sell another call option to continue earning premiums, creating a consistent income stream.
Pros And Cons Of Short Calls
The main advantage of a short call is the immediate premium income received from selling the option. However, it carries significant risk, as the potential for unlimited losses exists if the asset price rises above the strike price.
Pros:
- Premium Income: The short call provides immediate income through the premium received when selling the option, regardless of whether the option is exercised.
- Profit from Declining or Stable Markets: In a stable or declining market, the option expires worthless, allowing the seller to keep the premium as profit.
Cons:
- Unlimited Risk: The main risk is unlimited losses if the price of the underlying asset rises significantly, as the seller may need to buy back the option at a higher price.
- Requires Active Monitoring: To manage risk, short calls require constant monitoring and may need adjustments, such as buying back the option if market conditions change.
Pros And Cons Of Covered Calls
The main advantage of a covered call is generating additional income through the premium received from selling the call option. However, it limits the upside potential of the stock, as the shares may be called away if the price rises significantly.
Pros:
- Income Generation: By selling a call option, investors earn premium income, enhancing overall returns from the underlying stock.
- Downside Protection: The premium received from selling the call provides a small buffer against a decrease in the stock’s price, offering some downside protection.
Cons:
- Limited Profit Potential: If the stock price rises above the strike price, the investor must sell the shares, capping the potential upside profit.
- Opportunity Cost: If the stock price increases significantly, the investor misses out on higher gains since the stock will likely be called away at the strike price.
What Is The Difference Between Short Call And Covered Call? – Quick Summary
- A short call is when an investor sells a call option without owning the underlying asset, aiming for premium income, but faces unlimited risk if the asset price rises.
- A covered call involves owning the underlying asset and selling a call option on it. The investor earns premium income while potentially limiting the stock’s upside.
- A short call involves selling an option without owning the asset, while a covered call involves owning the asset and selling a call option on it.
- To trade a short call, sell a call option on an underlying asset. This generates premium income, but the risk increases if the asset price rises.
- To trade a covered call, buy or hold shares of an asset and sell a call option on it. This strategy generates income through premium received.
- Short calls provide premium income and profit in stable or declining markets but carry an unlimited risk if the asset price rises, requiring active monitoring.
- Covered calls generate income and provide downside protection but limit profit potential, as shares may be called away if the stock price rises significantly.
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Naked Call Vs. Covered Call – FAQs
A short call involves selling a call option without owning the underlying stock, while a covered call involves selling a call option while owning the underlying stock. The covered call provides protection as the stock can be delivered if the option is exercised.
A short call refers to selling a call option without owning the underlying asset. The seller hopes the price of the asset stays below the strike price, allowing the option to expire worthless, while keeping the premium received from the sale.
A covered call strategy involves holding a long position in an asset while selling a call option on the same asset. This allows the seller to earn premium income while potentially selling the asset at the strike price if the option is exercised.
A covered call is considered a neutral to slightly bullish strategy. It benefits from mild stock price increases or stability. The investor hopes the stock price will stay below the call’s strike price, allowing them to keep the premium without selling the stock.
In a covered call, an investor holds a stock and sells a call option on that stock. If the stock price stays below the option’s strike price, the option expires, and the investor keeps both the stock and the premium earned from selling the option.
The risks of a short call are potentially unlimited. If the stock price rises above the strike price, the seller may face significant losses, as they would need to buy the asset at market value to sell it at the lower strike price.
Covered calls limit the upside potential of a stock. If the stock price rises significantly above the strike price, the seller misses out on those gains, as the stock may be called away at the predetermined strike price, capping profits.
A short call is a bearish strategy, as the seller expects the price of the underlying asset to stay below the strike price. If the price rises, the seller faces potential losses, making it a high-risk, bearish approach.
Yes, you can buy back your covered call before it expires. If you decide to close the position early, you would repurchase the option, often at a price higher than the premium received, depending on the stock’s price movement.
Yes, a covered put is a strategy where an investor sells a put option while holding a short position in the underlying stock. It’s a bearish strategy where the investor aims to earn premium income while betting on the price falling or remaining neutral.
Disclaimer: The above article is written for educational purposes and the companies’ data mentioned in the article may change with respect to time. The securities quoted are exemplary and are not recommendatory.
