Short Call (Naked Call) Option Trading Strategy Explained

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

Short Call (Naked Call) Options Strategy

Strategy Level	Advance
Instruments Traded	Call
Number of Positions	1
Market View	Bearish
Risk Profile	Unlimited
Reward Profile	Limited
Breakeven Point	Strike 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 Rs 10400 (NIFTY Spot Price):

ITM Naked Call Order - NIFTY
Orders	NIFTY Strike Price
Sell 1 ITM Call	NIFTY18APR10200CE

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 Rs 48 (spot price) in June. The option contracts for this stock are available at the premium of:

July 50 Call - Rs 3

Lot size: 100 shares in 1 lot

Sell July 50 Call = 100 * 3 = Rs 300 Premium Received

Net Credit: Rs 300

Now let's discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at Rs 48

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

The total profit of Rs 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 Rs 68

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

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

Scenario 3: Stock price goes down to Rs 28

Same as scenario 1:

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

Example 2 - Bank Nifty

**Short Call Example Bank Nifty**
Bank Nifty Spot Price	8900
Bank Nifty Lot Size	25

**Short Call Options Strategy**
	Strike Price(Rs )	Premium(Rs )	Total Premium Paid(Rs ) (Premium * lot size 25)
Sell 1 ITM Call	8800	500	12500
Net Premium		500	12500

Breakeven(Rs )	Strike price of the Short Call + Net Premium (8800 + 500)	9300
Maximum Possible Loss (Rs )	Unlimited	Unlimited
Maximum Possible Profit (Rs )	Net Premium Received * Lot Size (500)*25	12500

On Expiry Bank NIFTY closes at	Net Payoff from 1 ITM Call Sold (Rs ) @8800	Net Payoff (Rs )
8800	0 (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

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)

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

Reward Profile of Short Call (Naked Call)

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

2 Comments

2. SANDEEP PUNWATKAR

| Link|Dec 30, 2020 7:14:11 PMReply

The options strategies are explained in a very easy and understandable way.
i am finding this web site an excellent one for beginners as far as stock market is concerned.
Thanks a lot for the useful information.

1. Dipayan Ray

| Link|Sep 5, 2019 1:04:34 PMReply

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