I will go into detail about selling a call option.
For many people, they don’t understand that you can sell options without having the stock or without owning the other options side of the trade. Selling call options or selling options, in general, is more popular amongst professionals than buying options contracts and that is because you can allow the time value or the time decay to work in your favor.
In either case, understand that there are four parts to trade.
- You can buy a call
- You can sell a call
- You can buy a put
- You can sell a put
In our case, we’re going to talk about selling a call option.
Selling a call option is very similar to selling a car that is not on a lot. Dealers or car dealerships – they often sell vehicles that aren’t even on the lot because you might want it in a different color, you might want different see different color seats, different little details and bonuses, add-on and unique features that they may not have on the lot.
What they typically do is the car they sell it to you, it’s already sold, but they order it make it for you. That’s ultimately what happens with selling call options.
Let’s take a look at in more detail about selling a call option – look at some profit pictures and risk profiles and then also look on-screen. How we can execute that trade and order.
What is a call option?
When you buy a call, it means you’re looking for the stock to go up. You have a bullish outlook, that’s an upward direction.
When you’re selling a call, it means you’re looking for the stock to go down. It’s a bearish outlook.
Typically, many people, the way they approach selling calls is they already have a stock position and then what they do is they sell upside calls, also known as they covered calls strategy against it.
Here’s a quick cheat sheet for you as far as looking at what happens.
When you’re a buyer of a call, you want stock prices to go up. When you’re a buyer of a put, you want stock prices to go down.
If you’re a seller of a call, you want prices to go down for that call. If you’re a seller of a put, you want stock prices to go up.
Taking a look at our risk profile picture here it is when we talk about selling a call.
The biggest issue or problem that we have here is the unlimited loss potential that we can get if that stock price continues to head higher.
The way that you read these risk profiles is again you have the profit here on the left and the loss and here is our zero line. Anything above that zero line is a profit-making, below that is the loss. Our stock price is towards the bottom – so as the stock price goes up, we lose money, and we can lose an unlimited amount based on this.
The black line is our call contract at expiration. This pink line continues to get closer to our black line with time. So over time, it gets closer and closer.
What happens here is we make money day in and day out, as that stock does not move or it moves to the downside.
Selling a call is actually like buying a put, as you can see. However, the difference is you have a cap or max profit. You can’t make any more than that.
If you sell a pair of shoes for $75, that is pretty much all you can get. You can get more in the future. You’re just making $75. All you can do is maybe lower your purchase price.
In our case, what’s happening is when we sell a call, we’re looking for a downside move, not an upside move. Ultimately, with time, that line continues to get closer and closer to expiration. That’s what we make on the profitability side. If we move downward, then we can make our full max profit potential.
Anyway, that gives you a little bit of insight into a risk profile picture of selling a call.
Let’s take a look at how to sell a call on an options trading platform
I want to show you what buying a put looks like on a risk profile picture.
You can see here I have a downside move. I need the stock or this option really to move to the downside.
Here’s our price level, here’s our zero line.
You can see that there’s my current price at the 154. I want that stock to move down because that’s what I make more money. As I move my mouse, you can see there’s my profit. If I move it down, there’s my loss.
What I can also do is move this to 150, which is a little bit closer. I can move it to even 155 – which gives me a little bit more acceleration there on the profit potential. So that way, if it goes to 145, I make $650.
The problem with this is if you’re buying a put. If the stock stands still, I’m losing $3.18 every single time. And with time continuing to move forward, you can see the losses here continue to add up.
As I continue to move the time and date forward, I continue to lose more and more money. I need this stock to move. If it stands still, I lose money because I’m below that zero line.
I need to move above that price point of about 151. If it goes down or actually if it goes to the upside, I lose money. If it stands still, I lose money. The only way I make money if it goes down, it has to go down in a pretty big way about four or five points on this stock.
With a call option, what’s different is if I go ahead and let’s say I sell this 160 call option and we’ll do a single. Again, take a look. I’m assuming the opposite side of the call or the call trade. Buying a call would be this way. I’m looking for unlimited profit potential here with buying a call.
You can see the advantage of selling a call because what happens is if a stock stands still, you make money. So if it’s right here, if it goes down, I make money. And if it goes up a little bit, I still make money and make my max profit up to 160, but I still make some money up to 161/162.
You can see how the probability of success increases with this. Unfortunately, you don’t have that unlimited upside money potential. In this case, you can make $200-300 if that stock explodes to 186. Now, the chance of that happening is unlikely, but you do have on the unlimited potential and a cap max loss of 163.
Whereas, if you sell the call you have an unlimited loss potential which is naked. You need to have an advanced option on level and capability could be able to do this.
For most people, they sell these call contracts because they own let’s say 100 shares of McDonald stock. For example, if I had 100 shares of McDonald stock, I could go ahead and sell a call contract against it.
What this allows me to do is think of it like two trades the McDonald’s stock, I make money from it from going up the call contract, I make money from it from staying under that 160. So if this McDonald’s stock doesn’t do anything and stand still, I usually don’t make any money. But because I have that call contract from selling it, what it allows me to do is make that additional $150 from just pretty much sitting still. If it continues to go up, I make my appreciation from my stock, but I lose a little bit of money from that option contract especially as it continues to head higher.
Now, the difference is because I have 100 shares of stock if it goes beyond it what they’ll do is they’ll take away my hundred shares of stock. That’s ultimately the dangers, whereas, if you sell this without stock, you’re continuing to go into a bigger and bigger loss because you own the stock at that 160 dollar price point okay.
If you didn’t own the stock, that’s where you have the problems.
But when you own the stock, maybe take your stock away at 160, so if it’s at 164, they make it elsewhere. You still get to keep that 150 dollars, and you get to sell your stock at 160. But if you want that stock and you want it back, you’ll have to repurchase it out 164.
That’s the downside, but we’ll get more in detail into covered calls in another video.
For now, understand and recognize that when you sell a call contract, you’re looking for prices actually to go down or you need it to stab you know below a certain.
Selling calls is a downward direction bias, that’s what you’re looking for you’re technically bearish on the position, or you’re neutral. If you want to stand still and hang out right there below a certain price level, then this is the position to put on now.
You could do it a little bit closer. Let’s say you were at 155, in that case. You’ll make more money. But you pretty much have that break-even at that 158 and your max at 155.
If you go wider, if I go to 160, I make less. I make 150, but I’m safer meaning I have a more significant range or a wider range. If I go to 165, I can go even wider. Now, I only make $51 on this one, but my chance of success is a lot higher.
You have to play with those probabilities based on your situation and risk levels, but that’s ultimately what you’re looking at with a call contract.