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Short Call (Naked Call) Options Trading Strategy Explained

Published on Wednesday, April 18, 2018 | Modified on Wednesday, June 5, 2019

Short Call (Naked Call)

Short Call (Naked Call) Options Strategy

Strategy LevelAdvance
Instruments TradedCall
Number of Positions1
Market ViewBearish
Risk ProfileUnlimited
Reward ProfileLimited
Breakeven PointStrike Price of Short Call + Premium Received

Short Call (or Naked Call) strategy involves the selling of the Call Options (or writing call option). In this strategy, a trader is Very Bearish in his market view and expects the price of the underlying asset to go down in near future. This strategy is highly risky with potential for unlimited losses and is generally preferred by experienced traders.

The strategy involves taking a single position of selling a Call Option of any type i.e. ITM or OTM. These naked calls are also known as Out-Of-The-Money Naked Call and In-The-Money Naked Call based on the type you choose. This strategy has limited rewards (max profit is premium received) and unlimited loss potential. When the trader goes short on call, the trader sells a call option and earn profits if the price of the underlying asset goes down. The trader receives the premium when he sells the call option. This premium is the maximum profit trader gets in case the price of underlying asset falls.

Let's assume you are bearish on NIFTY and expects its price to fall. You can deploy a Short Call strategy by selling the Call Option of NIFTY. If the price of NIFTY shares falls, the call option will not be exercised by the buyer and you can retain the premium received. However, if the price of NIFTY rises, you will start losing money significantly and rapidly on every rise.

This strategy has unlimited risk and limited rewards.

How to use the short call options strategy?

The short call strategy looks like as below for NIFTY which is currently traded at ₹10400 (NIFTY Spot Price):

ITM Naked Call Order - NIFTY
OrdersNIFTY Strike Price
Sell 1 ITM CallNIFTY18APR10200CE

Suppose NIFTY shares are trading at 10400. If we are expecting the price of NIFTY to go down in near future, we sell 1 NIFTY Call Option to implement this strategy.

If NIFTY falls as we expected, the call options will not be exercised by buyer and we will keep the premium received at the time of selling the call option. This is also the maximum profit in this strategy.

If NIFTY rises, the losses are unlimited. This makes it extremely risky strategy. This strategy should be used very carefully with bracket orders (stop loss).

When to use Short Call (Naked Call) strategy?

It is an aggressive strategy and involves huge risks. It should be used only in case where trader is certain about the bearish market view on the underlying.

Example

Example 1 - Stock Options (OTM Naked Call)

Let's take a simple example of a stock trading at ₹48 (spot price) in June. The option contracts for this stock are available at the premium of:

  • July 50 Call - ₹3

Lot size: 100 shares in 1 lot

  1. Sell July 50 Call = 100 * 3 = ₹300 Premium Received

Net Credit: ₹300

Now let's discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at ₹48

  • Sell July 50 Call: Expires Worthless
  • Net credit was ₹300 which was received as premium initally.
  • Total profit = ₹300 as we keep the premium.

The total profit of ₹300 is also the maximum profit in this strategy. This is the amount you received as premium at the time you enter in the trade.

Scenario 2: Stock price goes up to ₹68

  • Sell July 50 Call expires in-the-money with an intrinsic value of (50-68)*100 = -₹1800
  • Net credit was ₹300 which was received as net premium.
  • Total Loss = -1800 + 300 (Premium Received) = -₹1500

In this scenario, we lost total ₹1500. The loss could be significantly higher if the price of the stock keeps rising further.

Scenario 3: Stock price goes down to ₹28

Same as scenario 1:

  • Sell July 50 Call: Expires Worthless
  • Net credit was ₹300 which was received as premium initally.
  • Total proft = ₹300 as we keep the premium.

Example 2 - Bank Nifty

Short Call Example Bank Nifty
Bank Nifty Spot Price8900
Bank Nifty Lot Size25
Short Call Options Strategy
Strike Price(₹)Premium(₹)Total Premium Paid(₹)
(Premium * lot size 25)
Sell 1 ITM Call880050012500
Net Premium50012500
Breakeven(₹)Strike price of the Short Call + Net Premium
(8800 + 500)
9300
Maximum Possible Loss (₹)UnlimitedUnlimited
Maximum Possible Profit (₹)Net Premium Received * Lot Size
(500)*25
12500
On Expiry Bank NIFTY closes atNet Payoff from 1 ITM Call Sold (₹) @8800Net Payoff (₹)
88000
(8800-8800)*25
12500
12500-0
9000-5000
(8800-9000)*25
7500
12500-5000
9200-10000
(8800-9200)*25
2500
12500-10000
9400-15000
(8800-9400)*25
-2500
12500-15000
9600-20000
(8800-9600)*25
-7500
12500-20000
short call options strategy bank nifty

Market View - Bearish

When you are expecting the price of the underlying or its volatility to only moderately increase.

Actions

  • Sell Call Option

Breakeven Point

Strike Price of Short Call + Premium Received

Break even is achieved when the price of the underlying is equal to total of strike price and premium received.

Risk Profile of Short Call (Naked Call)

Unlimited

There risk is unlimited and depend on how high the price of the underlying moves.

Reward Profile of Short Call (Naked Call)

Limited

The profit is limited to the premium received.

Max Profit Scenario of Short Call (Naked Call)

When underline asset goes down and option not exercised.

  • Max Profit = Premium Received
  • Max Profit Achieved When Price of Underlying <= Strike Price of Short Call

Max Loss Scenario of Short Call (Naked Call)

When underline asset goes up and option exercised.

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying > Strike Price of Short Call + Premium Received
  • Loss = Price of Underlying - Strike Price of Short Call - Premium Received

Advantage of Short Call (Naked Call)

This strategy allows you to profit from falling prices in the underlying asset.

Disadvantage of Short Call (Naked Call)

There's unlimited risk on the upside as you are selling Option without holding the underlying.

Rewards are limited to premium received only.

How to exit?

  • Wait for option to expire and retain premium.
  • Buy back the Call Option.
  • Buy a Call Option at lower strike price.

Simillar Strategies

Covered Put, Covered Calls, Bear Call Spread

1 Comments

Dipayan Ray
1. Dipayan Ray  Sep 5, 2019 13:04 I Like It. | I Don't Like It. | Report Abuse Reply
I am delighted to see this portal with write-up on option strategies which is easily copy-able and can be used as ready reference. I find it quite lucid and relevant and, most importantly, it's with Indian exchange example & data. I am sure it will serve the need of option traders novice & experienced alike to get rid of confusions that are generally associated with the subject and instill in ideas deep in their psyche to form a sound base.
Your pay-off diagram is much superior to the ones usually available.I suggest if a relevant price chart with strategy-application in practical situation, could be provided-- that will help immensely crystallizing the idea of application for the needy.
It's a great job. Thanks.
Dipayan Ray








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