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Say you want to do a short call against a strike price of k, on 100 shares on a stock. Let's say the current price is c.

My question is: when you want to actually execute this call on a real platform, do you need to provide proof that you actually have 100 shares of the stock on you? If not, how does the exchange guarantee that you will be able to give your long trading pair their 100 shares when they exercise their right to buy them at a price of k?

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  • to try to make it simple, you either need (A) the stocks on hand or (B) a big pile of money on hand.
    – Fattie
    Jan 22, 2021 at 23:42

1 Answer 1

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In order to sell a covered call against 100 shares, you need Level 1 option approval. If you have Level 1 option approval and you try to sell the call without owning 100 shares, the broker's platform will prevent you from doing so.

In order to sell a naked call without owning the shares, you need a margin account, Level 4 or 5 option approval (some brokers have 4 levels, others 5), and sufficient margin to support the position.

The mechanics of assignment and exercise are handled as well as guaranteed by the Option Clearing Corp.

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  • thank you for clarifying! Just another quick question - when I look at the graph for short call, I see that the payoff goes negative when the price nudges above the strike price. My question is, how is this negative value calculated? Let's say I purchased those shares a long time ago, when they were worth 0.001k. And now I do a short call with those shares, just like in the question. Per my understanding, I should be on a profit no matter what happens. If the price increases, the longer trading pair will exercises his right and buy them at k, giving me a huge profit
    – nz_21
    Jan 21, 2021 at 22:05
  • If the price decreases, then I'm making money off the premium and still retain the shares. So not losing anything
    – nz_21
    Jan 21, 2021 at 22:10
  • I don't see the graph that you're looking at so I'd be guessing about what you are describing. I suspect that the negative value refers to the call's value above the strike price (not the payoff). The best that I can do is explain with an example. If you buy the stock for $55 and sell a $60 covered call for $2, you have the potential to make $7. Above $60, for every $1 that you make on the stock you lose $1 on the call. So $62 is the opportunity loss point. At $63, the call is worth -$3 (negative because you are short). -$55 + $63 +$2 -$3 equals $7 (the aforementioned maximum profit). Jan 21, 2021 at 23:31
  • If the price decreases, then I'm making money off the premium and still retain the shares. So not losing anything. Covered calls have an asymmetric risk/reward. In return for a small premium, you bear all of the risk of the stock dropping so it is quite possible that you can lose something and that something could be large. Jan 21, 2021 at 23:31
  • @nz_21 in general on these sites, please try to ask new questions in a new question
    – Fattie
    Jan 22, 2021 at 23:43

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