Picture this: you have been tracking a stock that has stayed right at the level of ₹1,000 for the last few weeks. Each time the stock seems to be able to break through, it pulls back. 

There is no major news coming up, no strong momentum, and the stock has clearly settled into a trading range. You are confident that the stock is likely to remain below ₹1,000 for the foreseeable future. 

Now imagine that there is a way to monetise that confidence.

Some traders do just this. Rather than hoping for a big rally or crash they are getting paid for betting the market is going to stay just where it is. The idea is simple. If you believe that a stock is not going to go above a certain price, you can benefit by taking money upfront by way of premium. If you are correct the premium is yours to keep.

Of course, a short call trade does come with risk. If the market takes off above the price you were counting on, your losses can be substantial. Thus, experienced traders who are comfortable putting a short call trade on, can manage the risk and have a solid view of market behaviour. 

What is a Short Call Strategy?

Before we can get into the mechanics of the short call strategy, it is necessary to understand the concept of “shorting” as it relates to trading.

Short selling is the process of selling an asset that one does not own with the intent of repurchasing it later at a lower price. An investor will employ short selling when they expect the price of an asset to drop. In other words, the larger the decline in price, the more profit the short seller stands to gain when they repurchase the asset.

With regards to options, the person selling an option is called the option writer. When the writer is selling a call option, they are creating a new contract between themselves and the buyer. A purchased options contract gives the buyer the right (but not the obligation) to buy/sell an underlying asset at a specified strike price, during a specified period.

So, when someone is taking a short position on a call option, they are fundamentally expressing a bet that the price of the underlying asset will not rise but ideally fall or remain flat. Conversely, the option buyer is hoping for the opposite—an upward movement in price of the asset.

If the price of the underlying asset increases over the strike price, the value of the call option increases, and potential risk of loss occurs to the seller. If the asset price remains flat or below the strike price, the call option should expire worthless. In this case, the seller gets to keep the entire premium at the time of selling the option and that is the maximum profit the seller can obtain.

Making a Short Call

Imagine we are tracking a stock that is priced at ₹200. After evaluating market conditions and technical analysis, the trader makes a prediction that the stock will have a hard time making it past ₹220 anytime soon. From there, the trader could sell a call option with a ₹220 strike for a premium of ₹12, since they are somewhat bearish or neutral on the stock.

By selling the option to the option trader, the trader is paid ₹12 per share upfront. On the total option contract, depending on the lot size of 100 shares, the trader is credited ₹1,200 immediately to their trading account.

At expiry, the option will have two possible outcomes:

• If the stock is under ₹220: The call will expire worthless since the buyer will NOT exercise their right to purchase at a premium above market price. The seller keeps the premium in its entirety as profit.
• If the stock is over ₹220: The buyer will likely exercise their option, and the trader must now deliver their stock at the price of ₹220, while buying their stock at a premium market price (say ₹240), resulting in a loss of ₹20 per share (₹240-₹220), minus what was paid for the premium. Their net loss will be: ₹2,000 (₹20 x 100) – ₹1,200 premium = ₹800 loss.

In examples like these, profits are limited to what you collect in premium; but the risk is open-ended if the market price of the underlying assets rises—which is why you should approach a short call strategy with extreme caution.

Analysing the Short Call and Long Put

When traders have a market or a specific stock that they expect to go down, they might consider two popular options strategies: the Short Call and Long Put. While both options strategies would happen in a bearish market, they differ in terms of how they are structured, how profits and losses are defined, and finally the type of risk involved.

Before you decide which strategy is best for your market outlook, risk tolerances and experience, it is a good idea to learn how they differ.

Short Calls: Speculating Against Price Increases

When traders want to short a stock and sell a call option, they will typically use a short call. A short call is the sale of a call option before posting any shares of the underlying security. A typical option seller collects a premium from the buyer and hopes the underlying stock or security does not increase above the agreed upon price or strike price until the expiry date of the option. If the underlying stock price at expiry date is below the strike price, the short call will expire worthless, and the trader keeps the entire premium as profit.

When using this approach, the trader assumes the underlying stock price will not exceed the strike price. Therefore, if the stock price increases above the strike price, the trader could be obligated to sell the stock at the strike price. If the stock price continues to rise, the trader could have theoretically unlimited losses. For this reason, a short call is a high risk strategy that should be avoided by beginning traders.

Example:

You sell a call option for XYZ stock at a strike price of ₹500 for a ₹20 premium. If the price at expiration is at ₹500 or below you keep the ₹20 premium as profit. If the price has increased to ₹550 at expiration you will have lost ₹30 (i.e., price of ₹550 – strike price of ₹500 – premium of ₹20) times lot size.

This type of trading works best if you have a neutral or slightly bearish market posture and you have reasonable assurance the underlying stock will remain below the agreed upon price or strike price.

Long Put: Profit When Price Moves Down

The long-put approach involves buying a put option giving the trader the right (but not the obligation) to sell the underlying security at a pre-established price before expiry. The trader pays a premium to purchase the right. The justification is to have the stock price decrease below the strike price.

The value of the put option increases as the underlying price drops. The trader may either sell the put for a profit or exercise the put option to sell the underlying and realize a profit on the underlying price based on the value of the strike price minus the new price of the stock (as they will receive the exercise price of the put option). The maximum risk for this option will be the premium paid, which is a relatively conservative option for many traders.

Example:

You have a put option on stock ABC with a strike price of ₹600 and the option premium for that option was ₹25.

If the stock price drops to ₹550, that option would be worth ₹50, thereby realizing a net profit of ₹25 (₹50 – ₹25).

If the stock price stays above ₹600, you will have realized a loss of the premium only (₹25).

Long puts have good opportunity in very strong bearish markets where there is a clear expectation the stock price will sharply drop.

Key Differences at a Glance:

Feature	Short Call	Long Put
Market View	Used when the trader expects the price to stay flat or fall.	Used when the trader expects the price to fall sharply.
Position Type	You sell a call option and receive a premium.	You buy a put option by paying a premium.
Entry Cost	Brings in a credit (you receive money upfront).	Requires upfront payment (debit to your account).
Maximum Profit	Limited to the premium received.	Potentially high if the asset price falls significantly.
Maximum Loss	Unlimited if the asset price rises sharply.	Limited to the premium paid for the option
Risk Exposure	High, due to open-ended loss potential.	Lower, as the maximum loss is predefined.
Margin Requirement	High, because brokers demand extra capital for risk coverage.	Low, as no margin is typically required.

Understanding Theta in Short Call Strategies 

Theta is a measure of time decay. Specifically, it is the rate of decay of an option premium. This occurs when an option’s expiration date approaches (and the other market conditions remain the same).

Theta is favourable when you are on the seller side of a short call position. That is, the passage of time (particularly when close to the option expiration date) will slowly erode the premium value of the option. If the underlying asset stays below the strike price, the premium erosion will provide the seller a better opportunity to exit the position at breakeven or profit if they hold the position until expiration or liquidate the position before expiration.

Time decay is highest for at-the-money options, and it accelerates when you approach expiration. This is why sellers of short-term options can take advantage of the Theta effect when they anticipate little or no price movement. Although the Theta in the short call option strategies is positive, it cannot offset any short or sudden upward price movements in the underlying asset.

In summary, Theta is advantageous for short call option sellers; however, even though Theta is positive for these sellers, they must consider Theta against the effects of all of the other influences with which sellers must deal if they are going to manage risk, especially volatility and market direction.

Key Points to Know Before Selling Call Options

Before you sell a call option, there are a few very important things you need to consider.

Use in Neutral or Bearish Markets: You will only want to use this strategy if you are reasonably confident that the asset will not significantly exceed the strike price.

Limited Profit and Unlimited Risk: You get to keep the premium, but if the price rises dramatically over the strike price it could be an infinite loss.

Low margin: Some brokers will have a high margin because there is open-ended risk.

Risk Management: Take steps to protect your capital such as a stop-loss order or hedging.

Avoid in Volatile Events: Earnings events or news releases can create massive price movement and be unpredictable, it is best to avoid selling calls altogether.

Time Variables: In general, time can help you with your position given options usually decay in value with the passage of time. If you have a rapid price point, time does little for your options position.

This strategy is much better suited for more disciplined traders that understand their risk.

Conclusion

The short call strategy can perform well in neutral to mildly bearish environments and can provide consistent income through thoroughly researching premium collection opportunities. 

That said, as there is limited profit with unlimited risk, this strategy “short call” is only advisable if you have a strong conviction for the trade and a firm understanding of risk management.

This strategy may be employed best by traders who understand options pricing and have indirect and direct opportunities to monitor their position. When used judiciously, this strategy can be a useful addition to broader trading strategy.

FAQs

Is there risk associated with selling a call option?

Yes, selling a call option (particularly if not owning the underlying (naked call)) carries an unlimited amount of risk on the upside if the price exceeds the strike price. Risk should be managed for this type of trade.

Is the short call strategy for beginners?

The short call strategy isn’t discussed more broadly because of the potential risks, especially in terms of margin. Also, if you are considering using this strategy, you should be familiar with options and have solid risk management methods in place.

When should a short call strategy be assessed?

A short call strategy is best used in a directional market that is moving sideways or slightly bearish and the trader believes the underlying will remain below a certain price level (the strike price) before expiration.

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