Outlook: Bearish
If you're expecting a fall in the stock price, selling/writing a call option could immediately bring some cash to your brokerage account.
There are two types of call writing:
Covered Call: Owning a stock and selling a call.
Naked Call: Write option without owning the stock.
Strategies...
- Select stock with adequate liquidity.
- Sell call option with a strike price higher than current stock price.
- Preferably shorter term to expiration
Example...
VeriFone Systems Inc (NYSE:PAY) is trading at $38 on May 25, 2012.
- Sell the June 2012 $40 call option for $0.90.
 |
| Short Call |
Stock price fall to $35...
- June $40 Call option: Not exercised by buyer , $0
- Premium gain: $0.90
- Profit : $0.90
Stock price is traded at $40.90...
- June $40 Call : Exercised by buyer, loss $0.90
- Premium gain: $0.90
- Profit : $0.90 - $0.90 = $0
Stock price is traded at $45...
- June $40 Call: Exercised by Put Buyer, loss $5
- Premium gain: $0.90
- Profit : -$5.00 + $0.90 = -$4.10
- (The further stock price falls, the higher the risk)
Maximum Profit : $0.90 per share (call premium)
Maximum Loss : Uncapped loss if stock rises
Breakeven : Stock price = $40+$0.90 = $40.90
Covered call writing is one of the low-risk income strategy, you can generate income from the option you sold.
Naked call writing is a very risky strategy, you expose yourself to unlimited loss. If stock price skyrocketed, you need to buy back stock at the current market price to cover your short position.
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