Selling Short Calls.

Selling (also called "writing") call options means giving someone else (i.e., the option holder) the right to purchase an underlying stock or index at a given strike price. Option sellers have obligations, but they are rewarded with option premiums which they receive for the sale of the call options. If the options sold expire worthless, the option seller will have no further obligations and will profit from the premiums received.

Traders that sell call options believe the underlying stock or index will decline:

• If the price of the underlying security remains below the call's strike price at expiration, the option seller will make a profit on the short call transaction. The option seller's profit is limited to the premiums received for selling the calls;

• At expiration, if the price of the underlying security is above the short call's strike price, the option holder may choose to exercise the right to purchase the options at the strike price. If assigned, the option seller must sell the underlying stock or index at the call's strike price. Because a short call was sold (i.e., the option seller did not own the underlying security at the time the options were sold), the option seller is now required to purchase the underlying security at its current market price and deliver the shares to the option buyer at the strike price. If the market price is (significantly) above the option's strike price, the option seller will incur a loss (i.e., current price of the underlying - strike price of the option = loss). The reason why selling "naked" or uncovered call options is associated with such a high degree of risk is because the maximum loss is theoretically unlimited - there is no limit as to how high an underlying security may rise.

In flat to falling markets, written calls (short calls) can provide a trader with extra income. A call seller may keep the premiums received from the sale of the options. If at expiry, the price of the underlying security is below the option's strike price (i.e., the calls expire worthless), then the option seller has no further obligations.

Covered and Uncovered Calls:

A covered call is the sale of a call against stock already owned. The seller is rewarded with the premiums received from the sale of the calls. Option sellers have obligations: If at expiration, the option buyer chooses to exercise the option, the option seller may lose his or her stock (on which calls were written). If assigned, the option seller must deliver the stock to the option buyer at the strike price.

Even if you do not own an underlying security, you may still be able to sell calls and collect premiums. The option seller has an obligations: If the call buyer chooses to exercise the option, the option seller will have to buy the underlying at its current market price and then deliver it to the buyer - the option seller will however receive only the amount stated by the strike price. If the underlying security has gone up significantly since the option seller sold calls on it, the option seller could lose a considerable amount because the option seller will only receive the amount dictated by the strike price. This is why selling naked (uncovered) calls is the most aggressive and risky strategy an investor can use.

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