A short call or short put means you sell (write) an option and collect its premium up front. A short call profits if the stock stays below the strike; a short put profits if the stock stays above it. The seller's maximum profit is the premium, while losses can be large, so sellers often buy a further out-of-the-money option to cap risk (a credit spread). The worked MSFT example below is a bear call spread: sell the $245 call, buy the $250 call. This is educational, not investment advice.
The four basic terms
Most beginner options strategies combine four words: long, short, call, and put.
Long: Long is when you buy an option contract (each covers 100 shares).
Short: Short is when you sell an option contract.
Call: A call gives the buyer the right to buy 100 shares at the strike price until expiration.
Put: A put gives the buyer the right to sell 100 shares at the strike price until expiration.
There is someone who wants to write a contract, and then there is someone who wants to buy that contract. Also, the traders may be bullish or bearish on a particular underlying. Combining these four terminologies, we get four strategies- Long-call, long-put, short-call, and short- put.
In a short call, the shareowner writes call contracts on his shares, and the buyer of the contracts gets an opportunity to buy them at a specific price, which is also called the strike price. The shareowner does this for a short term benefit on his share in the form of a premium. One important thing to notice here is that though the writer sells call options, he is bearish on the stock so that the options expire worthlessly, and he gets to keep his shares along with the premium.
Similarly, in the short-put strategy, when a shareowner is bullish on a stock, he will write off-put options to earn short-term profits as premium, and the buyer gets the right to sell that stock at the strike price. There is a separate article for long-put, where it is explained very well.
The most a writer can earn is the premium, no matter how the stock moves. A naked short call has unlimited risk, and a short put can lose down to a stock price of zero, so position size and protection matter.
Trading with MarketXLS
I will be explaining the short call with the help of a template from MarketXLS. MarketXLS is an Excel add-in that pulls stock and options data into Excel. Apart from this, it also provides templates to manage and track options trades for different strategies. Here, I have used Microsoft(MSFT) options as an example. This trade is not taken in real, and it is just for explaining. As I am writing this article, the MSFT shares are trading at $242.
Let’s assume that the trend will be bearish in the next couple of days. Therefore, I wrote off a call option at $245, which will expire on 12-Feb-2021. But there is one more leg in which I bought a contract in the same underlying at $250. That’s because I want to place a safety net if at all the share starts trading above $245. The long $250 call caps the loss if MSFT rallies through the short strike. Selling the $245 call for $1.56 and buying the $250 call for $0.52 gives a net credit of $1.04 per share ($104 per spread, before commissions). The MarketXLS template lets you add as many legs as the strategy needs.
Profits, losses, and breakeven
We have sold an out of the money contract (100 shares) of MSFT with a strike price of $245 at a premium of $1.56 and bought another contract with a strike of $250 at a premium of $0.52. Let’s have a look at the possible scenarios:
1. If MSFT finishes below $245, both calls expire worthless and you keep the $104 net credit. This is the maximum profit.
2. Between $245 and $250, the short call has value and the profit shrinks; at $246.04 the trade breaks even.
3. Above $250, the long call caps the loss at the $5 strike width minus the credit: $500 - $104 = $396 per spread. This is the maximum loss.
Therefore, it mostly depends on what a trader wants from a particular trade.
The breakeven point is $245 + $1.04 = $246.04 (before commissions).
Conclusion
A short call or short put earns the premium when the stock stays on the right side of the strike, and adding a protective long option turns it into a credit spread with a known maximum loss. Owning shares is not required, but a call written against 100 owned shares (a covered call) behaves differently from a naked short call. MarketXLS templates help track these trades in Excel; options data is end-of-day on the Standard plan and real-time on the Advanced and Business plans.
Disclaimer
None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person.
The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein.
the article is written to help users collect the required information from various sources deemed an authority in their content. The trademarks, if any, are the property of their owners, and no representations are made.
References
Read the options definition. Read the Short Call strategy reference.
