What is a 'Short Call'

A short call means the sale of a call option, which is a contract that gives the holder the right, but not the obligation, to buy a stock, bond, currency or commodity at a given price. If an investor thinks the price of the instrument will fall, he can sell short the underlying instrument, as well as the corresponding call option. While owning the call is protection against a rise in the price of the underlying security, selling the call generates cash while creating potentially unlimited risk.

BREAKING DOWN 'Short Call'

When an investor takes a short call position, the security's price must fall in order for the strategy to be profitable. If the price rises, there is unlimited potential for loss unless the seller owns the security, which is referred to as a covered call, or unless the writer uses the sale as part of a broader, complex option strategy. The sale of the call without owning the underlying security is referred to as a naked call.

Strike Price

A call option is usually written, or sold, at a price above the instrument's current market price. This is because the buyer wants the right to buy at the strike price if the market price moves above that. The closer the strike is to the current market price, the more expensive it is and the bigger the premium that the writer receives. However, it also has a greater chance that it expires "in the money." If the market price rises above the strike, the writer's potential loss is unlimited if it's a naked call.

Options Strategies

Investors sometimes use the sale of a call to finance the purchase of the underlying security or another option. A collar is a strategy in which the owner of a security buys a put with a strike that is below the current market price, and sells a call with a strike above current market; both options are thus "out of the money." If the market price is between the two strikes at expiration, the underlying security can be sold at the then-current market price. The sale price is protected on the downside by the purchase of the put, while the investor gives up the potential gain beyond the strike on the written call.

Pricing

In addition to the strike price, the major factors that influence the price of an option are volatility and maturity. High volatility increases the likelihood that any given option will expire in the money, and thus increases its price. Longer maturity also increases the likelihood that an option will end in the money, and therefore raises the price.

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