Have you heard of sell call options? Investing in the stock market can be a rewarding experience, but it can also be a challenging one. One way to potentially increase your profits is by selling call options.
A call option is a contract that gives the buyer the right, but not the obligation, to purchase a stock at a predetermined price (strike price) within a specific time period. When you sell a call option, you receive a premium upfront and agree to sell the stock at the strike price if the buyer exercises their option.
Selling Call Options
Selling call options can be a great way to generate income and potentially profit from a stock that you own. However, it can also be a risky strategy if not done correctly. In this article, we will discuss the basics of how to sell call options, including the benefits and risks involved, the factors to consider when selecting a stock and strike price, and strategies to help minimize your risk and maximize your potential profits. By understanding the ins and outs of selling call options, you can add a valuable tool to your investing arsenal and potentially enhance your overall returns.
Terms You Should Understand
As we move on in this study, here are some terms we may most likely use;
Option Contract
An agreement is made between a buyer and a seller.
Underlying Asset
The specific stock and its quantity, are usually set at 100 shares.
Calls and puts
A call option is the right to buy, while a put option is the right to sell.
Strike price
The strike price is the pre-agreed price at which an options contract can be executed when exercised.
Expiration date (expiry)
The expiration date, also known as the expiry, is the date when the contract becomes invalid.
Writer and Holder
The seller of an option is called the writer, while the buyer is referred to as the holder.
In the money (ITM)
In the money (ITM) means the option is considered profitable
At the Money (ATM)
The money (ATM) means the option is at a break-even status.
Out of the money (OTM)
out of the money (OTM) means the option is considered unprofitable.
Options
In the stock market, options are financial contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset, such as a stock or index, at a predetermined price (strike price) on or before a specified date.
There are two main types of options: calls and puts. A call option gives the holder the right to buy the underlying asset at the strike price, while a put option gives the holder the right to sell the underlying asset at the strike price.
When an investor buys an option, they pay a premium to the option seller. The option seller, in turn, assumes the obligation to sell or buy the underlying asset if the option holder chooses to exercise their option.
Options can be used for a variety of purposes in the stock market, including hedging against potential losses, generating income, and speculating on the direction of a stock or index. However, options trading can be
Types of Call Options
The various types of call options are;
Covered call/Buy-write call
A covered call or buy-write call is a strategy of selling a call option on a stock that you already own or plan to buy. According to Robert R. Johnson, a finance professor at Creighton University, it is a low-risk investment strategy that generates extra income, especially for retired investors who need additional income.
If the stock price remains the same or drops by the expiration date, the seller keeps the entire premium and the contract expires. However, if the price rises, the seller must sell the stock at the strike price, and the profit or loss will be the premium plus the difference between the stock’s purchase price and the strike price.
This strategy’s primary benefit is that it restricts losses in case the underlying stock doesn’t perform as expected.
Naked Call
In this case, you do not own the underlying stock in the first place.
If the stock is at OTM at the time of expiration, you keep the premium and the contract is worthless.
If the underlying stock is ITM, you must purchase it at the higher strike price and then sell it to the buyer at the lower strike price. The premium plus the strike price minus the cost of purchasing the stock at the new higher price will be your profit (or loss). These losses may be limitless.
The primary benefit of a naked call is that you do not have to invest any money until the underlying stock does not move as expected.
Sell to close
Sell to close is a strategy in which the original buyer of a call option decides to sell their option to take advantage of a stock that is in the money (ITM).
This allows the buyer to profit from selling the option instead of exercising it with the original seller. By selling the option to a new buyer, the original buyer can pocket the premium as a profit and close their position.
The new buyer may exercise their option before expiration, which would require the original seller to sell the stock to them at the new strike price. The main advantage of selling to close is the ability for the original buyer to become a seller before expiration, thereby avoiding commissions and other fees.
What Does it Mean to Sell a Call Option?
Call option sellers anticipate that the underlying security will either remain ATM or OTM at the time of expiration, allowing them to earn the full premium as profit. The degree of risk involved depends on their position with respect to the underlying stock, as previously explained.
In case you own or purchase the underlying stock and predict a decline in price, selling a covered call option may be an option. You can collect the premium and recover some of the expected loss or even make a profit if you select the strike price appropriately. This strategy carries less risk compared to selling a naked call option because you do not rely on a rising stock price to fulfill your obligation to sell the underlying asset.
“Having a trading plan is particularly crucial when dealing with shorter-term options,” cautions Nick Griebenow, Portfolio Manager for Shelton Capital Management’s Option Overlay Strategies. “Unlike holding a stock for an extended period, this type of trade will come to an end by the expiration date at the latest. Therefore, have predetermined exit points in mind, both at a profit and a loss, before entering the position.”
Frequently Asked Questions
When Is It Time to Sell a Call Option?
If an investor believes that a particular asset will fall in value, he or she will sell a call option.
When Is It Time to Sell a Put Option?
If an investor believes that the underlying security will rise, he or she will sell a put option.
What Are the Risks of Selling Options?
When the market moves negatively and there is no exit strategy or hedge in place, selling options can be risky. Even though worst-case scenarios are unlikely, it is important to be aware of their existence.
Selling a call option exposes you to the risk that the stock will continue to rise indefinitely, with no upside protection to limit your loss. As a result, call sellers must decide when they will choose to buy back an option contract.
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