Visually construct and analyze options strategies

Short Call

Options Strategy - Short Call

Description

The investor writing Call options should firmly believe that XYZ is not going up! XYZ doesn't have to go down, but it most definitely cannot go up. This is because the strategy's break-even point at expiration is a certain distance above the then current stock price. Thus, depending on the option's strike price, writing Call options can be a viewed as a neutral to bearish strategy.

Writing Calls: Why?

Writing uncovered ("naked") Call options is a strategy with very high risk for a small potential return. Given this obvious imbalance, why would a prudent investor wishing to preserve and build his or her capital write Calls?

  • Unaware of less risky "bearish" strategies.
  • Strongly believes XYZ "can't go any higher," and therefore, blind to the potential risks.
  • Time Decay.

Risk/Reward Characteristics

Break-even Point: At expiration, the break-even point (B.E.) is equal to the strike price of the Call option plus the Call option's premium. Before expiration, the break-even point is lower.

Profit: Profits are limited no matter how large the decline in XYZ.

Loss: Losses are unlimited!!

Time Decay: A Call option's premium consists of both intrinsic value (if any) plus time value. As time passes, the time value portion of the Call erodes (i.e., decays). At expiration, the Call's value will equal its intrinsic value.

Changes in implied Volatility: Changes in the option's implied volatility has an effect on the "time value" portion of an option's premium.

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