Hi Friends. I hope you all were able to understand Long Call, the
simplest of Options Strategy. Today we will take up an equally simple,
yet interesting strategy named – Short Call
So without further ado, let’s understand it.
We can use a Short Call Strategy when we are bearish in the market or
a particular type of underlying and we expect the prices to fall. In
this strategy we sell the Call in the assumption that the underlying
will come down sharply. This position offers limited profit potential
and the possibility of unlimited losses in case the rates of the
underlying increases significantly.
Though the strategy is very simple and easy to understand, execute
and profitable, please remember that this strategy has unlimited risk
compared to very limited profits.
When can we use this strategy??
We can use this strategy when we are bearish about a particular stock
or index. The reason for using this strategy is that there is a high
probability for success when selling very out-of-the-money options.
Risk involved while using this strategy
Unlimited Risk is involved if the index or stock shoots up
Benefits of using the strategy
Limited profits. Maximum profit will be the premium at the time of writing (selling) the call.
When can we achieve the breakeven?
The break-even point for us will be Strike Price + Premium
Example
NIFTY is currently trading around 8400. Let’s assume you are
extremely bearish on NIFTY. So you sell one lot of current month Call
with 8200 strike price at a premium of Rs. 150.
If the Nifty goes at or below 8300, the call option will not be
exercised by you and you will be able to retain the maximum premium of
Rs. 150 as profits . In case the Nifty stays above 8300, you will incur
an unlimited loss of {(Strike Price – Expiry Price) + Premium}
The Analysis of the Strategy
We use this strategy when we highly expect a fall in the price of the
underlying. But his is a risky strategy as our profits are extremely
limited (Rs. 150 in this case) but the losses are unlimited as we tend
to lose a lot of money if the underlying index or stock keeps moving up.
Therefore this strategy should either be used when we are certain that the underlying will go down or with a stop loss.
We hope that you are finding our new series on Options Strategies
Informative as well as interesting. We will soon come up with another
strategy, so stay tuned and keep leaning.
Have a happy time trading folks.