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A buyer and a seller are the two essential elements of any trading system, and they are also necessary in the realm of options trading. Even though you have probably done a good amount of study on purchasing options, it is still beneficial to gain more knowledge about selling alternatives. Selling call options, in particular, call for a few unique tactics that enable the seller to benefit in a given market. So, let’s explore all about sell call option example and how does selling call options work through this post: –
What is Call Options?
A call option is a financial instrument that grants its owner the right, but not the obligation, to purchase a particular underlying stock within a particular time frame (referred to as the “expiration”) at a predefined price (referred to as the “strike price.”
The call buyer pays the call seller a “premium” per share in exchange for the opportunity to purchase the stock. One hundred shares in each contract represent the underlying stock. Buying or selling a call does not need investors to possess the underlying stock.
Rather than purchasing the underlying stock straight, you might want to think about purchasing a call option if you believe the market price will increase. You might think about selling or “writing” a call option if you believe the market price of the underlying stock will remain unchanged, move in one direction or another, or decline.
In the event that the underlying share price moves in your favour, a call buyer has two options: either purchase the underlying shares at the strike price or “exercise” the call option. American options give the holder the flexibility to exercise the right at any time before it expires. Only the expiration date is available for exercising European options.
More intricate option strategies can also include the buying and selling of call options.
What are Selling Call Options?
Writers, also known as call option sellers, provide call options with the expectation that they will expire worthless. By keeping the premiums (discount) they receive, they make money. The option buyer’s profit will be reduced, and they can even lose money if they exercise their option profitably. At the same time, the price of the underlying securities rises above the option strike price.
Types of Selling Call Options
There are two primary ways in which an investor can sell call options before expiration however, individual investor tactics may vary:
- Covered Call
The seller is the one who owns the call option’s underlying asset in this selling call method. Because the seller has already purchased the asset at a lower price than the strike price, this method of selling calls is considered low risk. As a result, the seller protects against the possibility of losing money and is entitled to the benefit as extra money.
- Naked Call
The underlying asset of the call options is not owned by the seller, in contrast to the covered call. This selling call strategy is, therefore, seen as having a high degree of risk because the seller is not shielded from any losses by virtue of asset ownership.
Although the risk associated with these two types of selling call techniques may vary, each has advantages and disadvantages of its own. For example, because there are significant risks involved, the selling call strategy using naked calls frequently has lower upfront expenses. However, regardless of the direction of the asset’s price movement, selling call options with covered calls guarantees that the seller is in a secure position.
Benefits of Selling Call Options
When it comes to trading, there are two main strategies: buying and selling. While buying call options allows for potential gains with limited risk, selling call options can also be a profitable strategy with its own set of benefits.
- Generate Income: By selling call options, the seller receives a premium from the buyer. This premium serves as income for the seller and can be a consistent source of passive income if done regularly.
- Capitalise on Time Decay: As time passes, an option’s value decreases due to time decay. By selling call options, sellers can capitalise on this time decay and potentially buy back the option at a lower price, generating profits.
- Lower Risk than Buying: Selling call options comes with limited risk. The maximum loss for the seller is the difference between the stock’s market price and the strike price, plus any fees or commissions. This can be significantly lower than the potential losses when buying call options.
Factors to Consider Before Selling Call Options
When the point is of how to sell a call option contract then remember it can be a profitable strategy, it is important to consider several factors before implementing it.
- Stock Volatility: Highly volatile stocks may not be ideal for selling call options, as the potential for large price movements can lead to unexpected losses.
- Strike Price: The call option should be carefully chosen. A higher strike price means a higher premium but also a higher likelihood of the option being exercised. It is important to assess the potential risk and reward for each strike price.
- Time Horizon: Sellers should consider how long they are willing to hold onto the underlying asset before selling call options. A shorter time horizon may result in lower premiums but also decrease the chances of unexpected losses due to market fluctuations.
When to sell a call options?
Now that we understand the basics and pros of selling call options, let’s dive into the strategy of when to sell them. Keep in mind that this is a generalised approach and it is important for traders to assess their own risk tolerance and market research before making any investment decisions.
- High Implied Volatility
One factor to consider when deciding when to sell call options is the implied volatility of the underlying stock. Implied volatility is an indication of how much the market expects a stock’s price to fluctuate in the future. A higher implied volatility means a higher premium for selling call options.
- Near Expiration
As mentioned earlier, time decay works in favour of sellers by decreasing the value of the option as it nears expiration. Therefore, selling call options closer to their expiration date can result in a higher premium for sellers.
- In-the-Money Options
In-the-money options have a strike price that is lower than the recent market price of the underlying asset. These options have a higher chance of being exercised, resulting in the seller having to sell their asset at a lower price than the market value.
- Bullish Market Outlook
Selling call options is a bullish strategy, meaning it benefits from an increase in stock prices. Therefore, when market trends are pointing towards a bullish outlook, it may be a good time to sell call options.
- Diversification
It is important for traders to diversify their investment portfolio and not rely on one strategy or type of asset. By selling call options in addition to other investment strategies, traders can minimise risk and potentially increase profits.
The Bottom Line
Selling call options is not suitable for everyone as it requires a certain level of knowledge and risk tolerance. However, when done correctly, it can be a profitable strategy for generating income and managing risk in your investment portfolio. Remember to do your research and consult with a professional financial advisor before making any decisions.
FAQs
Not all stocks have options available for trading. It is important to check with your broker on which stocks have active option markets before attempting to sell.
Both buying and selling call options come with their risks and rewards. Selling call options does have limited risk, as the major losses are capped at the premium received. However, sellers must be prepared for potential market movements and have a plan in place for unexpected losses.
Yes, depending on your country and tax laws, there may be tax implications for profits made from selling call options. It is important to consult with a financial advisor or do research on your specific situation.
Yes, it is possible to sell call options on other types of assets, such as commodities or currencies. However, the strategies and risks involved may differ from selling call options on stocks.