What is a Short Call in Options Trading

In options trading, a short call option refers to the strategy of selling a call option, which involves giving someone the right but not the obligation to buy an underlying asset (like stocks) from you at a specified price (the strike price) before a given expiration date.

While the terms “selling a call” and “short call” are used interchangeably, it's essential to understand how these terms are related and why this strategy is referred to as “short.”

Understanding the Short Call Strategy

A short call is the opposite of a long call. When you sell (or “write”) a call option, you're entering into a contract with the option buyer. By doing so, you grant them the right to purchase the underlying asset from you at the agreed-upon strike price. However, the buyer is not obligated to do so. The option can expire worthless if the price doesn’t reach the strike price.

In essence, a short call can be seen as a bearish strategy reflecting an expectation that the price of the underlying asset will either stay the same or decrease, causing the option to expire unexercised.

Short vs. Long Calls: What’s the Difference?

When it comes to call options, the terms short and long describe the position you're taking:

Long Call – “I pay a small premium for the right to buy a stock at $55, and if the price rises to $60, I can profit by purchasing it at the lower price within the week.”

The long call has limited risk (the premium paid for the call) and unlimited profit potential as the price can rise infinitely.

Short Call – “I receive a premium for giving the buyer the right to buy the stock at the strike price, even if the stock rises significantly within the set time frame.” 

This strategy aims to profit if the price of the underlying asset does not rise above the strike price. The potential risk is unlimited as the price can rise indefinitely, while the maximum profit is limited to the premium received.

Why Does Selling a Call Option Mean a Short Call?

In simple terms, when you sell a call option, you're short that option. The term "short" in trading refers to a position where you are selling something that you don’t own. 

What Does "Short" and "Long" Mean?

• Short: In the context of options, being “short” means selling an option (call or put).
  
  
• Long: In contrast, being “long” means buying an option (call or put).
  
  

How Does a Short Call Work?

Expiration Scenarios:

• • If the stock price stays below the strike price at expiration: The option expires worthless, and you keep the premium as profit.

  • If the stock price rises above the strike price at expiration: The option is exercised, and you're obligated to sell the stock at the strike price, potentially incurring a loss if the stock price is significantly higher than the strike price.

Selling naked calls (short calls) without owning the underlying stock—is extremely risky because the potential losses are theoretically unlimited. If the stock price surges beyond your strike, you’re still required to sell it at that lower strike price, and you’ll need to buy the shares at market value to do so. The higher the stock climbs, the more you lose, with no defined ceiling to cap your risk. This is why traders typically avoid naked calls. Many experienced traders consider covered calls a safer alternative for newer investors, as the risk is limited to foregone upside. However, this strategy may not suit every investor’s needs.

Why Do Traders Use Covered Calls?

A variant of short call, covered calls are often considered a safer and more rewarding approach for traders looking to generate consistent income from their existing stock positions.

Traders use the covered call strategy when they believe the price of the underlying asset will remain flat or increase slightly. By selling a call option while already owning the stock, traders receive a premium upfront. If the stock price rises above the strike price, they may be required to sell their stock at the strike price, which is still a good outcome since they've locked in a profit from both the stock appreciation and the premium received from selling the call. If the stock doesn’t rise to the strike price, the option expires worthless, and the trader keeps the premium, enhancing their total returns.

Common Confusions Traders Might Have About Short Call Options

While short calls are an effective options strategy, they come with their own set of misconceptions and confusions that traders often encounter:

Confusion Between Short Calls and Covered Calls:

• • Short call: Involves selling a call option without owning the underlying asset. It carries unlimited risk because you may have to buy the asset at a much higher market price than the strike price.

  • Covered call: Involves selling a call option while owning the underlying asset. The risk is limited because you already hold the stock and will simply sell it at the strike price if the option is exercised.

Why it matters: A covered call is considered safer since it’s "covered" by the shares you already own. With a short call, you're exposed to the risk of needing to buy the stock at a higher price than you sold it for.

Confusion Between Short Calls and Naked Calls:

Confusion Between a Short Call and a Long Put:

Both a short call and a long put can be used when expecting a decline in the price of an underlying asset. However, the strategies are fundamentally different:

• Short call: You sell the right for someone else to buy the asset from you.
  
  
• Long put: You buy the right to sell the asset at a specific price.
  
  
  

Final Thoughts on Short Calls

A short call strategy offers limited profit potential (the premium) but unlimited risk, making it a highly speculative and potentially risky strategy. Some experienced traders may use the short call strategy when they believe a stock will remain flat or decline, even with the significant risks. 

Traders who use short calls often mitigate risks by utilizing other strategies, such as covered calls or protective stops, to help manage potential losses.