Thursday, 11 April 2013

Short Call - Bearish Strategy


Short Call: Selling a Call is a strategy that must be opted when the option trader is mildly bearish on the market. On selling a Call, the investor earns a Premium (from the buyer of the Call).

This strategy is a high risk venture with limited profit and a possibility of unlimited loss potential. 
Although easy to execute it is a risky strategy since the seller of the Call is exposed to unlimited risk.



Nifty Options Sell Call
Sell 1 OTM Index Call

Investor View: Bearish on Index or Stock

Risk: Unlimited

Reward: Premium Received – (Brokerage + Statutory Charges)

Illustration:

Index
Nifty
Nifty Lot Size
50
Underlying Strike Price
5600
Call Premium
`      63.45 ( Call Premium Received)
Breakeven Point
` 5663.45 (Strike Price + Premium Received)


Sell Call 

Profit

  • Max Profit: Premium Received – (Brokerage + Statutory Charges)
  • Profit Achieved when Nifty Settlement Value <= Nifty Strike Price i.e 5600

Loss 

  • Max Loss = Unlimited
  • Loss Occurs When Price of Nifty  > Strike Price of Short Call + ( Premium Received – Brokerage + Statutory Charges)
  • Loss = Price of Nifty Settlement Value - Strike Price of Short Call - Premium Received + Brokerage Paid

Breakeven Point: Formula for Breakeven point Breakeven point:
            Nifty Call Option Strike Price + Premium Received

Nifty Closing Price @
Profit/Loss
5400
3172.50  (Profit)
5500
3172.50  (Profit)
5600
 3172.50 (Profit)
5700
1827.50  (Loss)
5800
 6827.50 (Loss)



Let us assume Nifty is currently trading at 5550. An options trader decides to Sell(writes) Nifty Apr 5600 out-of-the-money naked call for Rs 63.45. So trader receives premium of Rs 3172.5 (63.45 X 50 Lot Size) for Selling Call Option

On expiration date, the Nifty had rallied to Rs 5700. Since the Nifty strike price of 5600 for the call option is lower than the current trading price, the call is assigned his net loss is Rs 1827.5 ((Nifty Settlement Value i.e 5700- Nifty Call Option Strike Price 5600)-Premium Paid i.e 63.45)

However, let’s take a look where nifty closes down at 5500

At Rs5450, the call expires worthless and the writer of the naked call keeps the Rs 3172.5 (63.45 X 50 Lot Size) in premiums received as profit.

From the profit graph above, we can see that the breakeven is at Rs 5663.45 (Call Strike + Premium). So long as the stock price remains at Rs 5663.45 or below, the naked call writer will not suffer any loss.


For More Information about other strategies kindly click on below links
Guide To Options Basics
Long Call
Long Put
Short Put
Long Straddle
Short Straddle
Synthetic Long Call