This chapter covers the fundamentals of short call options contracts. To get comfortable with the language used when discussing options, watch this video:
When an investor goes short a call, they’re bearish on the underlying security’s market price. Selling a call creates an obligation: if the option is assigned (exercised), the writer must sell the stock at the strike price.
Let’s work through a few examples to understand short calls better:
Short 1 ABC Sep 75 call @ $6
This contract obligates the writer to sell ABC stock at $75 per share if assigned. The writer received $600 for selling the option ($6 premium x 100 shares). The contract expires on the third Friday in September.
By selling this call, the investor is betting ABC’s market price stays at or below $75 through expiration. If ABC rises above $75, the holder may exercise, which can create losses for the writer.
Math-based options questions should be expected on the exam. They typically ask for potential gains, losses, and breakeven values. Let’s go through each.
An investor goes short 1 ABC Sep 75 call @ $6. The market price rises to $100. What is the gain or loss?
Can you figure it out?
Answer = $1,900 loss
| Action | Result |
|---|---|
| Sell call | +$600 |
| Buy shares | -$10,000 |
| Assigned - sell shares | +$7,500 |
| Total | -$1,900 |
The market price rose to $100, so the option is $25 in the money ($100 − $75). We can safely assume the investor is assigned, which requires selling 100 ABC shares at $75.
If the writer doesn’t already own the shares, they must buy 100 shares in the market at $100 and then sell them at $75. That creates a $2,500 loss ($25 x 100). After including the $600 premium received upfront, the net loss is $1,900.
The higher the underlying security’s market price rises, the more a call writer loses if assigned. Imagine the market price rising to $125, $200, $250, and so on. Because there’s no ceiling on how high a stock price can go, the maximum loss for a short call is unlimited.
When an option is sold with no hedge (protection), it’s considered naked. A naked short call is especially risky because assignment can force the investor to buy shares at the higher market price and then sell them at the lower strike price. Since the market has no ceiling, the potential loss is unlimited.
In future sections, you’ll learn how investors protect themselves from risk on short options. For now, here is a quick list of investments that would cover a short call:
You may have noticed a pattern in the list above. If the writer already owns the shares, or can obtain shares through something convertible (preferred stock or bonds) or exercisable (rights or warrants), they can avoid the need to buy shares at the higher market price.
While the maximum loss for a short naked call is unlimited, call writers don’t always lose large amounts. Even if the option goes in the money (gains intrinsic value), the writer doesn’t have an overall loss until the assignment loss exceeds the premium received.
Let’s go through another example:
An investor goes short 1 ABC Sep 75 call @ $6. The market price rises to $81. What is the gain or loss?
Answer = $0 (breakeven)
| Action | Result |
|---|---|
| Sell call | +$600 |
| Buy shares | -$8,100 |
| Assigned - sell shares | +$7,500 |
| Total | $0 |
At $81, the option is $6 in the money ($81 − $75). Assuming the option is exercised (a safe assumption), the investor buys ABC shares at $81 (the market price) and sells them at $75 (the strike price). That’s a $6 per share loss, or $600 total.
The $600 premium received upfront offsets the $600 assignment loss, so the investor breaks even.
The breakeven for short call contracts can be found using this formula:
Did you notice the breakeven formula for long calls is the same? Since the long and short positions are opposite sides of the same contract, they share the same breakeven point.
If ABC’s market price doesn’t rise too far past $75, the investor can still have a profit overall. For example:
An investor goes short 1 ABC Sep 75 call @ $6. The market price rises to $79. What is the gain or loss?
Answer = $200 gain
| Action | Result |
|---|---|
| Sell call | +$600 |
| Buy shares | -$7,900 |
| Assigned - sell shares | +$7,500 |
| Total | +$200 |
At $79, the option is $4 in the money ($79 − $75). Assignment creates a $4 per share loss because the investor buys ABC shares at $79 and sells them at $75. That’s a $400 loss ($4 x 100).
After including the $600 premium received upfront, the net result is a $200 gain.
Expiration is the best-case scenario for investors writing (going short) options. If the option expires unexercised, the writer keeps the premium and never has to fulfill the obligation. The same applies to short call contracts.
An investor goes short 1 ABC Sep 75 call @ $6. The market price falls to $73. What is the gain or loss?
Answer = $600 gain
| Action | Result |
|---|---|
| Sell call | +$600 |
| Total | +$600 |
At $73, the option is $2 out of the money because the market price is below the $75 strike price. When the market price is at or below $75, the holder won’t exercise. There’s no reason to buy stock for $75 when it’s trading for $73.
This is the best-case scenario for the call writer: they sold the call for $600 and the option expires.
A quick way to judge whether a call is likely to be assigned is the phrase “call up.” Calls are exercised when the underlying security’s market price is above the strike price. That isn’t true here, so the option expires.
Investors with short options can only make the premium, nothing more. If exercise occurs, losses start reducing that premium and can eventually turn the position into a net loss.
Writers can also perform closing transactions to exit their obligations before expiration.
An investor goes short 1 ABC Sep 75 call @ $6. After ABC’s market price rises to $79, the premium rises to $9, and the investor performs a closing purchase. What is the gain or loss?
Answer = $300 loss
| Action | Result |
|---|---|
| Sell call | +$600 |
| Close call | -$900 |
| Total | -$300 |
To find the profit or loss on a closing transaction, compare:
Here, the investor received $6 when selling the call and paid $9 to close it. That’s a $3 net loss per share. Since one options contract represents 100 shares, the total loss is $300.
Here’s a visual summarizing the important aspects of short calls:
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