What Is a Short Call?

By Markets Fool.com

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There are plenty of ways to profit on a stock's movement beyond investing in the actual stock itself. Options provide a nearly endless array of strategies, due to the countless ways you can combine buying and selling call option(s) and put option(s) at different strike prices and expirations.

A call is an options contract that gives the owner the right to purchase the underlying security at the specified strike price at any point up until expiration. A put is an options contract that gives the owner the right to sell the underlying asset at the specified strike price at any point up until expiration.

If you sell a call, then you are taking the short side of that contract and may be obligated to deliver shares of the underlying security at the specified strike price if the call is exercised. You will receive an upfront premium for selling the call.

Covered or naked

Two common scenarios for selling a call are covered calls and naked calls. Typically, the goal in both of these strategies is for the stock to remain below the strike price, in which case it will expire worthless and you keep the premium.

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A covered call is a fairly conservative strategy, where you currently own the underlying stock. This simplifies the delivery as you previously purchased the stock. Covered calls are a popular method to create income off a stock position, which is particularly useful if it is not a dividend-paying stock and you wish to generate income. However, you must be comfortable with selling the stock at the strike price in case the stock rises above the strike price and is exercised.

A naked call is an extremely risky strategy, where you do not currently own the underlying stock. This complicates the delivery as you may need to go out and purchase the stock at prevailing market prices in order to deliver the stock at the strike price. Since there is no theoretical limit to how high a stock can go, the potential risk is very great.

Spreads

Beyond those two strategies, there are countless other strategies that can be created with spreads, which involve buying and selling various combinations of calls and/or puts with different strike prices and expirations. However, spreads are beyond the scope of this article.

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