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 are 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 focus on 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). That’s bad for the seller.
If the investor is assigned, they must sell 100 shares at $75. If they don’t already own the shares, they must buy 100 shares in the market at $100 and then deliver them at $75.
The higher the underlying security’s market price rises, the more a call writer loses if assigned. For example, if the market price rose to $125, $200, or $250, the loss would be even larger. 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 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 manage risk on short options. For now, here is a quick list of investments that would cover a short call:
*For a long call to cover a short call, the long call must maintain the same or lower strike price, plus the expiration must be the same or longer.
**A short call is considered covered if a banking institution provides a guarantee letter stating it will cover the costs related to an assignment.
You may notice a pattern in the list above: if the writer already owns the shares, or can obtain them through conversion (preferred stock or bonds) or exercise (rights or warrants), they can deliver shares without having to buy them 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 intrinsic value 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). If the option is exercised (a safe assumption), the investor buys ABC at $81 and sells at $75.
The breakeven for 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 opposites, it makes sense that they break even at the same stock price.
If ABC’s market price doesn’t rise too far above $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). If assigned, the investor buys ABC at $79 and sells at $75.
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.
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. The holder won’t exercise - there’s no reason to buy at $75 when the stock is available in the market for $73.
A quick way to think about assignment for calls is the phrase “call up.” Calls are exercised only when the market price is above the strike price. That isn’t true here, so the option expires.
With short options, the most the investor can make is the premium received. Any exercise-related loss reduces that premium and can push the position into an overall loss.
Writers can also perform closing transactions to exit their obligation 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 sold the call for $6 and later bought it back for $9.
Here’s a visual summarizing the important aspects of short calls:
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