A call options seller is a trader who believes in a falling market and expect
to profit from the downward move. By selling call options a trader becomes bound
by obligation to sell the underlying stock at a specific price before or at the
expiration date. Selling call options on a stock that is owned by a trader is
called "covered call writing" or selling a covered call. The covered call has
limited risk. When a trader is selling naked calls (uncovered calls), the
involved risk is theoretically unlimited, even though the profits are limited.
There are some benefits with this strategy.
A call seller receives a premium for selling someone the right to purchase an
asset at a particular price. If the sold calls are not exercised then the
collected premium provides additional income, if the asset price is below the
strike price at expiration. On the other hand a call seller is obliged to sell
the asset at the exercise price, if the calls sold get exercised and if the
stock price goes up, a call seller may loose more than the received premium.
Furthermore, selling calls is considered a more risky options trading strategy
then buying puts. As a rule, options brokers require that traders meet
additional margin requirements in order to sell naked call options (uncovered
options).
On the positive side, the time decay of the option works in favor of the call
options seller. The time-value portion of the call premium constantly declines
with time, going to zero on the expiration date. The closer to expiration the
faster option loses its value. For this reason, it is often better to sell calls
with one month or less until expiration.
To understand the involved risks is very important. Your risk is unlimited if
you sell naked calls. If the stock price rises and stays at about the strike
level at the expiration, the call seller is obliged to sell the asset at the
agreed-on strike price or cover the option.
Before selling the call, it is important to analyze your expectations for the
underlying asset. You can write the call approximately at-the-money and collect
a larger premium, if you expect the asset price to remain stable. The premium
you collect will be even larger if you sell an in-the-money call, but in this
case you run a greater risk of the option being exercised.
