Risk and Reward Characteristics of Selling a Call Option
Selling versus
buying options is a less familiar concept to many
Investors. However, because option trading is a
zero-sum game there is just as much money
made or lost selling options as buying them, so investors should
become more knowledgeable in selling options, too.
Here presents
the profit and loss potential in the present and at
expiration of selling a March 100 call for $5. Many
of the characteristics of selling options are
opposite to the ones of buying them. For example,
the profit potential is limited but the loss
potential is not limited and similar to being short
the future. The profit and loss potential at
expiration is the same as being short the future at
105 when the future is above 105. The most the call
writer can make is $5 no matter how low the future
drops, whereas the short seller
can profit substantially if the market drops
significantly.
The three possible
scenarios for selling options are:
-
If the market is
below 100 the future will probably not be assigned, so the call
seller should expect to make $5 from the premium
received.
-
If the market
is at 100, the future may be assigned, which
would make the seller short the future at 100.
If assigned the future, the seller can buy the
future back at 100 and breakeven on the trade,
but still receive the $5 premium from selling
the call.
-
If the market rises to 105, the call seller will be assigned the
future, which would mean being short the future
at 100. The trader would purchase the future at
105 in the open market and lose $5 to close out
the trade ($100 -
$105
= -$5). However,
the $5 premium received from selling the call
would offset the loss incurred in buying back
the future, so the call seller would breakeven
at 105. If the market rises above 105 the call
seller will lose the same amount as being short
the future at 105.
The call writer
will make a profit as long as the future is
below 105 at expiration, but may begin to lose
substantial amounts if the market rallies
sharply. The price of the call exhibits the same
sensitivity to a price change in the future as
described previously in buying a call.
Risk and Reward Characteristics
of Selling a Call Option