An investor who sells a call believes that the underlying stock price will fall and that they will be able to profit from a decline in the stock price by selling calls. An investor who sells a call is obligated to deliver the underlying stock if the buyer decides to exercise the option. When looking to establish a position, the seller must determine:

  • Their Maximum Gain
  • Their Maximum Loss
  • Their Breakeven

Maximum Gain Short Calls

For an investor who has sold uncovered or naked calls, maximum gain is always limited to the amount of the premium they received when they sold the calls.

Maximum Loss Short Calls

An investor who has sold uncovered or naked calls does not own the underlying stock and, as a result, has unlimited risk and the potential for an unlimited loss. The seller of the calls is subject to a loss if the stock price increases. Since there is no limit to how high a stock price may rise, there is no limit to the amount of their loss.

Determining The Breakeven for Short Calls

An investor who has sold calls must determine where the stock price must be at expiration in order for the investor to breakeven on the transaction. An investor who has sold calls has received the premium from the buyer in the hopes that the stock price will fall. If the stock appreciates, the investor may begin to lose money. The stock price may appreciate by the amount of the option premium received and the investor will still breakeven at expiration. To determine an investor’s breakeven point on a short call, use the following formula:

Breakeven = Strike Price + Premium

Example:

An investor has established the following option position: Short 1 XYZ May 30 call at 3.

The Investor’s maximum gain, Maximum loss, and breakeven will be:

Maximum Gain: $300 (The amount of the premium received) Maximum Loss: Unlimited

Breakeven: $33 = 30 + 3 (Strike price + premium)

If at expiration XYZ is at exactly $33 per share and the investor closes out the transaction with a closing purchase or has the option exercised against them, they will breakeven excluding transactions costs.

Notice the relationship between the buyer and the seller:

  Call Buyer Call Seller

Maximum Gain

Unlimited

Premium Received

Maximum Loss

Premium Paid

Unlimited

Breakeven

Strike price + Premium

Strike price + Premium

Wants Option To

Exercise

Expire

Because an option is a two-party contract, the buyer’s maximum gain is the seller’s maximum loss and the buyer’s maximum loss is the seller’s maximum gain. Both the buyer and the seller will breakeven at the same point.

Need Help Passing Your Series 4 Exam?

Buying Puts

Related Articles
  1. Trading

    Going Long On Calls

    Learn how to buy calls and then sell or exercise them to earn a profit.
  2. Trading

    How To Buy Options On the Dow Jones

    We show why buying options on the Dow Jones is a good alternative to trading the exchange-traded fund.
  3. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  4. Trading

    The Basics of Covered Calls

    Learn how this simple options contract can work for you, even when your stock isn't.
  5. Trading

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
  6. Trading

    Stock Futures vs Stock Options

    A full analysis of when is it better to trade stock futures vs when is it better to trade options on a particular stock. A quick overview of how each of them works and why would a trader, investor, ...
  7. Trading

    Fix Broken Trades With The Repair Strategy

    You can recover from your losses if you know how to use this handy trader's tool.
  8. Trading

    What is a Bear Call Spread?

    A bear call spread is an option strategy that involves the sale of a call option, and the simultaneous purchase of a call option (on the same underlying asset) with the same expiration date but ...
  9. Trading

    What is a Bull Call Spread?

    A bull call spread is an option strategy that involves the purchase of a call option, and the simultaneous sale of another option (on the same underlying asset) with the same expiration date ...
Frequently Asked Questions
  1. Do interest rates increase during a recession?

    Learn why interest rates do not rise in a recession; in fact, the opposite happens. Identify the factors that reduce interest ...
  2. What is the difference between deflation and disinflation?

    Learn what deflation and disinflation are, how supply and demand affect price levels, and the difference between deflation ...
  3. What rights do all common shareholders have?

    Learn what rights all common shareholders have, and understand the remedies that can be taken if those rights are violated ...
  4. What does CHIPS UID mean?

    Learn what CHIPS UID stands for and how it facilitates the transfer of funds as the back-end of the ACH network for both ...
Trading Center