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optionsplaybook.com 2 - Options Playbook

Short Call

AKA NAKED CALL;UNCOVERED CALL

Short call spread strategy - Options Playbook

The strategy

Selling the call obligates you to sell stock at strike price A if the option is assigned.

When running this strategy, you want the call you sell to expire worthless. That’s why most investors sell out-of-the-money options .

This strategy has a low profit potential if the stock remains below strike A at expiration, but unlimited potential risk if the stock goes up. The reason some traders run this strategy is that there is a high probability for success when selling very out-of-the-money options. If the market moves against you, then you must have a stop-loss plan in place. Keep a watchful eye on this strategy as it unfolds.

Options guys tips

You may wish to consider ensuring that strike A is around one standard deviation out-of-the-money at initiation. That will increase your probability of success. However, the higher the strike price, the lower the premium received from this strategy.

Some investors may wish to run this strategy using index options rather than options on individual stocks. That’s because historically, indexes have not been as volatile as individual stocks. Fluctuations in an index’s component stock prices tend to cancel one another out, lessening the volatility of the index as a whole.

The setup

Sell a call, strike price A
Generally, the stock price will be below strike A

Who should run it

All-Stars only

NOTE: Uncovered short calls (selling a call on a stock you don’t own) is only suited for the most advanced option traders. It is not a strategy for the faint of heart.

When to run it

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You’re bearish to neutral.

Break-even at expiration

Strike A plus the premium received for the call.

The sweet spot

There’s a large sweet spot. As long as the stock price is at or below strike A at expiration, you make your maximum profit. That’s why this strategy is enticing to some traders.

Maximum potential profit

Potential profit is limited to the premium received for selling the call.

If the stock keeps rising above strike A, you keep losing money.

Maximum potential loss

Risk is theoretically unlimited. If the stock keeps rising, you keep losing money. You may lose some hair as well. So hold onto your hat and stick to your stop-loss if the trade doesn’t go your way.

Margin requirement

Margin requirement is the greater of the following:

25% of the underlying security value minus the out-of-the-money amount (if any), plus the premium received
OR 10% of the underlying security value plus the premium received

NOTE: The premium received from establishing the short call may be applied to the initial margin requirement.
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After this position is established, an ongoing maintenance margin requirement may apply. That means depending on how the underlying performs, an increase (or decrease) in the required margin is possible. Keep in mind this requirement is subject to change and is on a per-contract basis. So don’t forget to multiply by the total number of contracts when you’re doing the math.

As time goes by

For this strategy, time decay is your friend. You want the price of the option you sold to approach zero. That means if you choose to close your position prior to expiration, it will be less expensive to buy it back.

Implied volatility

After the strategy is established, you want implied volatility to decrease. That will decrease the price of the option you sold, so if you choose to close your position prior to expiration it will be less expensive to do so.

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