The original column has been published (shortened
) in Dutch on September 7 at Telegraaf's DFT.nl / Goeroes / Opties 2.0 – deel 7. Basis Optiestrategie; Short Call

__Basic options strategies__

In my previous article of August
29th, "Basic Option Strategies; Long Put", you read all about the
second basic option strategy, the Long Put.

Today I’m going to cover the third
basic option strategy: the Short Call

__Short Call (Selling a Call option)____Structure__

A Short Call consists of a single
leg; the Sale of a Call option.

__Application__

A Short Call becomes attractive when
you expect either a neutral movement and/or a decrease in the price of the
underlying asset.

A Short Call can also be used to
generate an extra return on your portfolio.

__Investment__

With a Short Call you’ll initially
receive money. The investment amounts to the number of contracts that you sell
x the Call option price x the contract size. If you sell 4 Call options for
5.50, then you’ll receive 4 * 5.50 * 100 = 2,200 Euros.

__Margin__

The Short Call strategy comes with a
margin obligation. This means that you aren’t free to spend the received
investment and that you must maintain a specific margin as security (to offset
potential future losses) in addition. The Margin obligation is calculated and settled
on a daily basis. And also intraday for the various banks and brokers.

__Break-Even Point__

You’ll reach the break-even point
upon expiration if the price of the underlying asset is equal to the strike
price of the Call option + the price that you received for the Call option. The
Call option now has only an intrinsic and no longer a time value. Which is why
your result is 0.

__Profit__

You’ll make a profit upon expiration
if the price of the underlying asset is below the break-even point.

__Maximum Profit__

The maximum profit that can be
achieved using a Short Call is limited to the Call Option premium received. Upon
expiration, the Call has a value equal to the price of the underlying asset
minus the strike price. If upon expiration, the price of the underlying asset
is lower than the strike price of the Call option, then the Call option has no
remaining intrinsic value. The Call option will expire at 0 and you’ll realise
the maximum profit.

__Loss__

You’ll make a loss upon expiration
if the price of the underlying asset is above the break-even point.

__Maximum Loss (Risk)__

Your maximum loss is unlimited! So
the higher the price of the underlying asset, the greater the value of the Call
option. And the greater your loss.

__Price of the Underlying Asset (Delta) Influence__

Negative. A Short Call has a
negative Delta. A higher underlying asset price results in a higher Call option
premium.

__Remaining Maturity (Theta) Influence__

Positive. Time works to your
advantage with a Short Call strategy, because the remaining time value of the
Call option reduces daily.

__Volatility (Vega) Influence__

Negative. A higher volatility
indicates a greater remaining time value for the Call option and thus a higher
Call option premium.

__Advantages__

The advantage of the Short Call is
that no price change is required to achieve a profit. For at-the-money and
out-of-the-money Call options, a consistent underlying asset price is
sufficient to achieve the maximum result.

__Disadvantages__

The disadvantage of the Short Call
is that the maximum loss is unlimited.

__Example__

Suppose that we sell a Call option
on the AEX-index with a strike price of 335.00 for a price of EUR 5.50. The AEX
lists it at 335.77 at that moment in time

One call option provides an investment
of -1 x 5.50 x 100 = - EUR 550.

The Call option premium includes a
time value of 4.73 (= 86%). Thus 5.50 – intrinsic (= 335.77 – 335.00) = 5.50 –
0.77 = 4.73. So, upon expiration the AEX price may rise by 4.73 (from 335.77 to
340.50 = +1.4%) in order to reach the break-even point. If the price were to
drop below 340.50 we would achieve a profit using this strategy. And if the
price were to drop below 335.00 (= -0.2%), we would realise the maximum profit
using this strategy.

Upon expiration the outcome would be
as follows:

Short Call Graphical Simulation:

The x-axis shows the various price
levels of the underlying asset.

The y-axis displays the (expected)
result. The blue line indicates the expected result one month prior to
expiration. The red line shows the result upon expiration.

__Pitfalls__

The most common pitfall for private investors
using Short Calls is to wait too long to close the position and take their
profit or loss.

**Options 2.0 ... Basic Options Strategy; Short Put**

In this article we’ve taken a look
at the third basic option strategy with a single leg; the Short Call. And we’ve
covered how to use it and what the advantages and disadvantages are.

In the next article we’ll examine
the fourth single leg options strategy; we’ll explore the Short Put.

*Herbert Robijn is founder and director of FINODEX (www.finodex.com). FINODEX develops innovative online investment tools for private equity and options investors. These cutting-edge tools allow investors to make a comprehensive market analysis, complex calculations and appropriate selections, at just the touch of a button.*

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