Stock Market Trading:
Selling Call Options
By selling a call option, you are selling the
right to buy the underlying stock or index at a particular strike price to
an option holder. Sellers have obligations. Selling a call option prompts
the deposit of a credit. You get to keep this credit if the option expires
worthless. A trader who sell call options believe that the market will fall.
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To make money on a short call, the price
of the security must stay below the call's strike price. The profit is limited
to the credit received from the sale of the call.
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If the price of the security rises above
the short call strike price, it will be assigned to an option holder who
may choose to exercise it. Other words the option seller must buy
the underlying stock or index at the current price and sell it at the call's
lower strike price (current price - strike price = loss). The maximum
loss is unlimited to the upside, which is why selling "naked" or unprotected
call options comes with such a high risk.
Covered and not Covered Call:
If you owned a stock you can sell the call
and receive the premium. This is called writing a covered call. If the stock
declines in price you keep the premium. If the stock goes up in price the
options buyer exercise the option and demands that you deliver the stock at
the strike price. In this case you loose your stock but you keep the premium.
If you did not own the underlying stock
you still might sell a call. If the stock goes down you keep the premium.
However, if the stock goes up and the call buyer exercises the option you
have to buy a stock to deliver it to the call buyer.
This this the most aggressive and risky strategy an investor
can use.
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