2

Referring to http://en.wikipedia.org/wiki/Option_(finance), for a short call:

If the stock price increases over the exercise price by more than the amount of the premium, the short will lose money, with the potential loss unlimited.

Assume the current stock price is $100, and I hold one stock. Then I sell a call option with a strike price of $100, expiring one year later, for a premium of $10.

So even if the stock price is $1000 a year later, I sell the stock at $100. I still earn the 10 bucks, so why am I going to have a loss? Even an unlimited loss? Is it about opportunity cost? I think it's unreasonable.

  • Note that in your example, you don't state what you paid for the stock. If you paid $400/share and sold it for $100/share then you'd have a loss whereas if you didn't write the call option you'd have a nice gain of $600/share. – JB King Oct 21 '14 at 3:09
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    Maybe i am not reading correctly, but the option consists of 100 shares of the stock, and you are only buying one share. – Victor123 Oct 23 '14 at 20:14
12

You are likely making an assumption that the "Short call" part of the article you refer to isn't making: that you own the underlying stock in the first place. Rather, selling short a call has two primary cases with considerably different risk profiles. When you short-sell (or "write") a call option on a stock, your position can either be:

  • covered, which means you already own the underlying stock and will simply need to deliver it if you are assigned,

    or else

  • uncovered (or naked), which means you do not own the underlying stock.

Writing a covered call can be a relatively conservative trade, while writing a naked call (if your broker were to permit such) can be extremely risky.

Consider: With an uncovered position, should you be assigned you will be required to first buy the underlying at the prevailing price in order to be able to fulfil your contractual obligation to sell/deliver the underlying to the exercising option holder for the [lower] contract exercise price. This is a very real cost — certainly not an opportunity cost.

Look a little further in the article you linked, to the Option strategies section, and you will see the covered call mentioned there. That's the kind of trade you describe in your example.

  • 1
    +1 Nice answer Chris, I was about to write something very similar. – Victor Oct 21 '14 at 3:37
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    Nice Answer Chris, I was about to write something completely different, in a foreign language, wrong and opinionated. – ssaltman Oct 21 '14 at 19:00
  • @ssaltman LOL! esp. 'wrong' – Chris W. Rea Oct 21 '14 at 19:08
  • "Writing a covered call can be a relatively conservative trade, "... while writing a naked call (if your broker were to permit such) can be extremely risky. Consider: With an uncovered position, should you be assigned you will be required to buy the underlying at the prevailing price." BUY the underlying if assigned on a naked call? – Bob Baerker Oct 24 '18 at 12:26
  • @BobBaerker Yes, exactly. "Buy" is not a typo. In the naked short call case, the writer of the option contract that's been assigned would have to buy the underlying shares in the market, at the prevailing market price, in order to then sell/deliver the underlying to the exercising option holder, at the option contract price. But, you're right that my answer could be confusing without mention of the subsequent sale/delivery of those shares. – Chris W. Rea Oct 24 '18 at 18:17
0

Well, if you are selling a call option, you have to obligation to sell that stock at the agreed price.

If today's stock price is $100 and you sell a call option for ... let's say $102 and stock 'shoots' up: then you buy the stock at $102 and sell it to the new price. You are out of the pocket [new price - $102] * 100 * number of contracts.

They say UNLIMITED because they think that stock could go up to infinite, which is unrealistic. But stocks cannot go too much up ...

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