How to do Short Call (Naked call) Options Trading strategy ?

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Let’s explore short call options trading strategy to understand it better. This discussion explains how they work in a simple way and includes beginner-friendly tips to make learning easier.

What is a Short Call (Naked call) Options?

A Short Call Options strategy, often called a Naked Call, is when you agree to sell something (like a stock) to someone, but you don’t actually own it at that moment. It’s like promising to sell a bicycle to a friend, even if you don’t own a bicycle yet.

How Short call works?

let’s break down Short Call Options using the bicycle example in simpler terms:

Imagine you have a special arrangement that allows you to promise your friend that you’ll sell them a bicycle in the future, but here’s the twist: you don’t actually own a bicycle right now. This arrangement is similar to what’s known as a “Short Call Options strategy.”

Here’s how it works:

1. The Promise: You make an agreement with your friend, stating that you’ll sell them a bicycle at a specific price (let’s say $200) whenever they decide they want to buy it from you.
2. No Bicycle Ownership: Importantly, you don’t currently own a bicycle. You’re essentially saying, “I’ll find a bicycle to sell to you at that price when you’re ready.”
3. Your Expectation: You use this strategy when you expect the price of bicycles to go down in the near future. You’re betting that you’ll be able to buy a bicycle for less than $200 when your friend decides to exercise their option.
4. Potential Profit and Loss: If bicycle prices do indeed drop below $200, you can buy one and sell it to your friend, making a profit from the price difference. However, if bicycle prices rise above $200 when your friend wants to buy, you might have to buy a more expensive bicycle to fulfill your promise, resulting in a potential loss.
5. No Obligation to Buy: It’s important to note that you’re not obligated to buy a bicycle until your friend decides to exercise their option. If they never want to buy, you don’t need to acquire a bicycle, and you won’t incur any losses.

So, a Short Call Options strategy is a bit like promising to sell a bicycle to a friend, even if you don’t actually own one yet. Your profit or loss depends on the future price of bicycles when your friend decides to make their purchase. This strategy is typically used when you anticipate that the price of the underlying asset (in this case, bicycles) will decrease.

Example of Short Call Options Strategy

For an instance Apple shares (TICKER SYMBOL: AAPL) are currently trading at about $100 each, and they’re going up in value. However, you, as a trader, believe that AAPL is actually too expensive and will eventually drop to $50 per share.

With this belief in mind, you decide to use a strategy. You sell a special contract called a Call Option with a price tag of $110 per AAPL share. For this contract, you receive $1.00 per share upfront, totaling $100 ($1.00 x 100 shares).

Now, if AAPL’s stock price does go down as you expect, the special contracts expire without anyone using them. You keep the $100 you received as your profit, and your strategy was successful.

Strategy Level	Advance
Instruments Traded	Call
Number of Positions	1
Market View	Bearish
Risk Profile	Unlimited
Reward Profile	Limited
Breakeven Point	Strike Price of Short Call + Premium Received

what are the risks?

But, here’s the tricky part: If AAPL’s stock price keeps going up instead, it can be a problem for you. Let’s say it reaches $200 in a few months, and someone decides to use the special contract to buy AAPL shares at $110 each. You have to enter the market and buy 100 AAPL shares at the current high price of $200 per share.

Here’s the outcome for you:

• You spend $20,000 to buy 100 AAPL shares at $200 each.
• You receive $11,000 from selling those shares for $110 each through the special contract.

This means you have a loss of $20,000 – $11,000 = ($9,000). When you factor in the $100 premium you initially received, your total loss is ($8,900).

In simple terms, you were hoping AAPL’s stock price would drop, but if it goes up a lot instead, you could end up losing a significant amount. This shows that writing Call Options can be risky when you’re not on the right side of the market movement.

When to use Short Call Options strategy?

Here are several scenarios where the Short Call Options strategy can be effectively deployed

1. Bearish Outlook:
   • When you expect a stock or asset’s price to fall, the Short Call Options strategy allows you to profit from the anticipated decline by selling Call Options.
2. Overvalued Stocks:
   • Short Call Options can be used to capitalize on the belief that a stock is overpriced and will eventually decrease in value.
3. Income Generation:
   • This strategy is employed to generate income by selling Call Options, particularly in low volatility markets or when minimal price fluctuations are expected.
4. Hedging:
   • The Short Call Options strategy can act as a hedge to protect existing long positions in an asset, helping offset potential losses if the asset’s price falls.
5. Range-Bound Markets:
   • In range-bound markets, this strategy is used to generate income by profiting from premiums when Call Options expire without being exercised within an expected price range.

IMPORTANT FACT : Remember this strategy can be relatively complex and comes with unlimited risk if the underlying asset’s price rises significantly.

Beginners can use the Short Call Options strategy, they should approach it with a focus on education, risk management, and careful monitoring to mitigate potential losses. It’s advisable for beginners to

1. Educate Themselves: Learn the basics of options trading, including how Call Options work, their risks, and potential rewards.
2. Start Small: Begin with a small number of contracts or a limited investment to gain experience without risking too much capital.
3. Practice: Consider paper trading or using virtual trading platforms to practice the strategy without real money at stake.
4. Seek Guidance: Consult with a financial advisor or take online courses to enhance their knowledge and skills.
5. Understand Risk: Be fully aware of the unlimited risk associated with Short Call Options and employ risk management strategies.

In conclusion, Short Call Options offer opportunities for traders, including beginners, to profit in bearish or range-bound markets. However, it’s essential to understand the strategy’s risks and benefits before diving in. To learn more about Call Options Trading and other option trading strategies, explore our options trading tutorial series.