Selling calls is a bearish options trading strategy that is also known by the name vertical bear calls. When an investor feels bearish on the market, a good strategy may be to engage in selling calls or selling bear calls. This is considered a bearish strategy because the trader profits if the underlying stock decreases in value. Basically, the strategy is to buy out-of-the-money call options and sell in-the-money call options on the same stock with the same expiration date. The plan is that the in-the-money stock closes lower than its strike price at its expiration date. Not the trader realizes maximum profits from selling calls.
When selling calls, the investor will experience maximum loss, when the stock price increases above the higher out-of-the-money call option strike price at the expiration date. This loss will be the difference between the two strike prices minus the net credit of the spread when it was originated. While there is risk involved this strategy allows investors to find profits even when the market is bearish by selling calls.
The downside of selling calls is that while it is lower risk than simply buying puts options, it also has limited profit potential. The break-even is at the lower strike price plus net credit. The maximum profit potential is when the stock decreases below the in-the-money call option strike price.
For example, an investor wants to sell calls on ABC, Corp. The stock price is $39.875. The trader sells an in-the-money call option with a June expiration at a strike price of $35 for $5. At the same time, the investor buys an out-of-the-money call option with a June expiration at a strike price of $40 for $1.56. Selling a call such as this is a net credit of $3.44 (spread of $5) or the difference between the costs of the two options. If the stock price is lower the in-the-money strike price on the expiration date, this would be a maximum profit of the net credit when selling the calls. ($5.00 – $1.56= $3.44 x 1 contract (100 shares) for a maximum profit of $344) Conversely, the maximum loss would be if the stock closed above the out-of-the-money strike price on its expiration date. ($5.00 Call Spread – $3.44 net credit received = $1.56 x 1 contract for a maximum loss of $156.00) Because the risk is low, the risk reward ratios when selling calls are still very good.
A successful trader will adequately investigate such a move prior to selling calls. That way he or she can be assured that the trade has a high probability of success. As with any trade the investor needs to understand the risks and potential profits involved in order to make a wise decision. Using a stock trading system such as Japanese Candlesticks, the investor has access to charts that are understandable and powerful data in the attempt to sell calls to make a profit.
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