In-The-Money Naked Call Explained

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Short Call (Naked Call) Options Trading Strategy Explained

Published on Wednesday, April 18, 2020 | Modified on Wednesday, June 5, 2020

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Short Call (Naked Call) Options Strategy

Strategy Level Advance
Instruments Traded Call
Number of Positions 1
Market View Bearish
Risk Profile Unlimited
Reward Profile Limited
Breakeven Point Strike Price of Short Call + Premium Received

Short Call (or Naked Call) strategy involves the selling of the Call Options (or writing call option). In this strategy, a trader is Very Bearish in his market view and expects the price of the underlying asset to go down in near future. This strategy is highly risky with potential for unlimited losses and is generally preferred by experienced traders.

The strategy involves taking a single position of selling a Call Option of any type i.e. ITM or OTM. These naked calls are also known as Out-Of-The-Money Naked Call and In-The-Money Naked Call based on the type you choose. This strategy has limited rewards (max profit is premium received) and unlimited loss potential. When the trader goes short on call, the trader sells a call option and earn profits if the price of the underlying asset goes down. The trader receives the premium when he sells the call option. This premium is the maximum profit trader gets in case the price of underlying asset falls.

Let’s assume you are bearish on NIFTY and expects its price to fall. You can deploy a Short Call strategy by selling the Call Option of NIFTY. If the price of NIFTY shares falls, the call option will not be exercised by the buyer and you can retain the premium received. However, if the price of NIFTY rises, you will start losing money significantly and rapidly on every rise.

This strategy has unlimited risk and limited rewards.

How to use the short call options strategy?

The short call strategy looks like as below for NIFTY which is currently traded at ₹10400 (NIFTY Spot Price):

ITM Naked Call Order – NIFTY

Orders NIFTY Strike Price
Sell 1 ITM Call NIFTY18APR10200CE

Suppose NIFTY shares are trading at 10400. If we are expecting the price of NIFTY to go down in near future, we sell 1 NIFTY Call Option to implement this strategy.

If NIFTY falls as we expected, the call options will not be exercised by buyer and we will keep the premium received at the time of selling the call option. This is also the maximum profit in this strategy.

If NIFTY rises, the losses are unlimited. This makes it extremely risky strategy. This strategy should be used very carefully with bracket orders (stop loss).

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When to use Short Call (Naked Call) strategy?

It is an aggressive strategy and involves huge risks. It should be used only in case where trader is certain about the bearish market view on the underlying.

Example

Example 1 – Stock Options (OTM Naked Call)

Let’s take a simple example of a stock trading at ₹48 (spot price) in June. The option contracts for this stock are available at the premium of:

Lot size: 100 shares in 1 lot

  1. Sell July 50 Call = 100 * 3 = ₹300 Premium Received

Net Credit: ₹300

Now let’s discuss the possible scenarios:

Scenario 1: Stock price remains unchanged at ₹48

  • Sell July 50 Call: Expires Worthless
  • Net credit was ₹300 which was received as premium initally.
  • Total profit = ₹300 as we keep the premium.

The total profit of ₹300 is also the maximum profit in this strategy. This is the amount you received as premium at the time you enter in the trade.

Scenario 2: Stock price goes up to ₹68

  • Sell July 50 Call expires in-the-money with an intrinsic value of (50-68)*100 = -₹1800
  • Net credit was ₹300 which was received as net premium.
  • Total Loss = -1800 + 300 (Premium Received) = -₹1500

In this scenario, we lost total ₹1500. The loss could be significantly higher if the price of the stock keeps rising further.

Scenario 3: Stock price goes down to ₹28

Same as scenario 1:

  • Sell July 50 Call: Expires Worthless
  • Net credit was ₹300 which was received as premium initally.
  • Total proft = ₹300 as we keep the premium.

Example 2 – Bank Nifty

Short Call Example Bank Nifty
Bank Nifty Spot Price 8900
Bank Nifty Lot Size 25
Short Call Options Strategy
Strike Price(₹) Premium(₹) Total Premium Paid(₹)
(Premium * lot size 25)
Sell 1 ITM Call 8800 500 12500
Net Premium 500 12500
Breakeven(₹) Strike price of the Short Call + Net Premium
(8800 + 500)
9300
Maximum Possible Loss (₹) Unlimited Unlimited
Maximum Possible Profit (₹) Net Premium Received * Lot Size
(500)*25
12500
On Expiry Bank NIFTY closes at Net Payoff from 1 ITM Call Sold (₹) @8800 Net Payoff (₹)
8800 0
(8800-8800)*25
12500
12500-0
9000 -5000
(8800-9000)*25
7500
12500-5000
9200 -10000
(8800-9200)*25
2500
12500-10000
9400 -15000
(8800-9400)*25
-2500
12500-15000
9600 -20000
(8800-9600)*25
-7500
12500-20000

Market View – Bearish

When you are expecting the price of the underlying or its volatility to only moderately increase.

Actions

  • Sell Call Option

Breakeven Point

Strike Price of Short Call + Premium Received

Break even is achieved when the price of the underlying is equal to total of strike price and premium received.

Risk Profile of Short Call (Naked Call)

Unlimited

There risk is unlimited and depend on how high the price of the underlying moves.

Reward Profile of Short Call (Naked Call)

Limited

The profit is limited to the premium received.

Money Heist explained: Why did Lisbon go into the Bank of Spain?

MONEY HEIST dropped its fourth series on Netflix on April 3 and fans have already binged the new series. Why did Lisbon go into the Bank of Spain?

WARNING: This story contains spoilers for Money Heist series four

Money Heist is now in its fourth series and all eight episodes have dropped on Netflix for fans to binge-watch.

One of the characters on everyone’s minds this season is Lisbon (played by Itziar Ituno), but she was not always known by that name.

Fans have been wondering why Lisbon entered the Bank of Spain in the new series, and here is everything you need to know.

In the first series of the Spanish crime drama Money Heist, or La Casa de Papel, Raquel Murillo is introduced as an inspector of the National Police Corps.

In the third season, she comes back with a new name – Lisbon, and the series focuses heavily on her relationship with The Professor (Alvaro Morte).

But in the fourth series, she goes back to working for the police and hopes to defeat the gang she had previously joined.

The price if she fails is 30 years in prison and there is a lot at stake for her in the new series.

Money Heist: Lisbon escaped custody (Image: Netflix)

Money Heist: Lisbon back in the bank (Image: Netflix)

READ MORE

In the third season, The Professor’s gang went inside the Bank of Spain as part of Berlin’s (Pedro Alonso ) heist plan, but it did not go as expected with Lisbon presumably dying.

In the fourth series The Professor came up with a plan to get Lisbon back – he had presumed her dead but she was actually in custody.

She was transported from the Spanish Intelligence custody and stood trial, where she revealed to the judge the gang’s plan to rob the Bank of Spain.

To those around her, it was a shock reveal but it was all part of a scheme, and with some help, The Professor tunnelled into the parking lot where Lisbon was being transported to the trial.

Money Heist: Lisbon escaping custody (Image: Netflix)

Money Heist: Lisbon with Sierra (Image: Netflix)

In order for the intelligence team to not suspect anything, a woman who looked like Lisbon was used in a swap and took her place before being taken to prison.

Some fans thought The Professor would see Lisbon again after her rescue but rather than bringing her back, he sends her to the Bank of Spain.

With Nairobi now dead after being shot in the head by a previous hostage who escaped, the gang is short of one player.

In order for them to succeed in their plan, Lisbon needs to be on the same side as them, and she is a pivotal character in the new series.

One fan tweeted following the latest series saying: “Take a moment and take a bow to the creators of Money Heist.

“Believe me when they achieved [taking] Lisbon to the Bank of Spain it was the best moment of the whole robbery.”

The gang and The Professor cheer as Lisbon is reunited with the group and they all share a hug, but the professor starts to look heartbroken.

He says to the group: “Listen to me, this war, we’re going to win.” Lisbon then says: “For Nairobi”.

READ MORE

Lisbon is played by Itziar Ituno, a Spanish actress who studied at Basauri Theatre School and made her debut in a thriller called The End of the Night in 2003.

She has since taken on more than 20 roles, including a role in the film Flowers and the Netflix feature film Twin Murders: The Silence of the White City.

The actress has just revealed she has tested positive for the coronavirus, and she posted on Instagram to tell her fans.

She said: “Today we have received confirmation of the epidemiological test. It is a coronavirus.

“My case is mild and I am fine but it is very very contagious and super dangerous for people who are weaker. Take care of yourself.”

Money Heist season 4 is available to watch on Netflix now

Why naked call writing is risky compare to Covered call?

I know that with a covered call you own the underlying and sell a call and with a naked call you don’t own the underlying. Either way, if the underlying finishes in-the-money, you are assigned and you have to sell the underlying shares at the strike price.

What I don’t get it why a naked call is so much riskier than a covered call writing?

5 Answers 5

If the buyer exercises your option, you will have to give him the stock. If you already own the stock, the worst that can happen is you have to give him your stock, thus losing the money you spend to buy it. So the most you can lose is what you already spent to buy the stock (minus the price the buyer paid for your option).

If you don’t own the stock, you will have to buy it. But if the stock skyrockets in value, it will be very expensive to buy it. If for instance you buy the stock when it is worth $100, sell your covered call, and the next day the stock shoots to $1000, you will lose the $100 you got from the purchase of the stock. But if you had used a naked call, you would have to buy the stock at $1000, and you would lose $900.

Since there is no limit to how high the stock can go, there is no limit to how much money you may lose.

There is unlimited risk in taking a naked call option position. The only risk in taking a covered call position is that you will be required to sell your shares for less than the going market price.

I don’t entirely agree with the accepted answer given here. You would not lose the amount you paid to buy the shares.

Naked Call Option

Suppose take a naked call option position by selling a call option. Since there is no limit on how high the price of the underlying share can go, you can be forced to either buy back the option at a very high price, or, in the case that the option is exercised, you can be force. to buy the underlying shares at a very high price and then sell them to the option holder at a very low price.

For example, suppose you sell an Apple call option with a strike price of $100 at a premium of $2.50, and for this you receive a payment of $250.

Now, if the price of Apple skyrockets to, say, $1000, then you would either have to buy back the option for about $90,000 = 100 x ($1000-$100), or, if the holder exercised the option, then you would need to buy 100 Apple shares at the market price of $1000 per share, costing you $100,000, and then sell them to the option holder at the strike price of $100 for $10,000 = 100 x $100. In either case, you would show a loss of $90,000 on the share transaction, which would be slightly offset by a $250 credit for the premium you received selling the call. There is no limit on the potential loss since there is no limit on how high the underlying share price can go.

Covered Call Option

Consider now the case of a covered call option. Since you hold the underlying shares, any loss you make on the option position would be “covered” by the profit you make on the underlying shares.

Again, suppose you own 100 Apple shares and sell a call option with a strike price of $100 at a premium of $2.50 to earn a payment of $250.

If the price of Apple skyrockets to $1000, then there are again two possible scenarios. One, you buy back the option at a premium of about $900 costing you $90,000. In order to cover this cost you would then sell your 100 Apple shares at the market price of $1000 per share to realise $100,000 = 100 x $1000. On the other hand, if your option is exercised, then you would deliver your 100 Apple shares to the option holder at the contracted strike price of $100 per share, thus receiving just $10,000 = 100 x $100. The only “loss” is that you have had to sell your shares for much less than the market price.

The math in these answers and comments is correct but most have mistakenly compared the opportunity risk of a covered call with the upside short risk of a naked call (the underlying rising in both positions).

Comparing the two properly requires defining whether to strike price sold is in-the-money, at-the-money, or out-of–the-money . and the answer will vary depending on which one is chosen. I’m not going to dissect all three. Since people tend to sell OTM covered calls more often than not, I’m going to go with OTM and my answer is going to set some hair on fire (g).

On an expiration basis, if you sell a naked call, it doesn’t become problematic until the underlying goes ITM. You have a buffer of the distance up to the strike price plus the premium received. For a covered call, if the underlying begins dropping, you lose on it immediately and your only buffer is the amount of premium received. IOW, in terms of risk, the naked call will outperform the covered call by the distance from underlying price to the strike price written. Well, sort of.

The limiting factor is that the underlying can only fall to zero whereas it can rise significantly more than that. Many quote that potential rise as unlimited but practically speaking, no stock has ever gone to infinity. Realistically, the naked call has upside less risk than a covered call until the amount of price rise is equal to the underlying’s price plus the distance to strike. Since words are often not as clear as numbers, consider an example:

XYZ is $20. Compare selling a $25 covered call for $1 with just selling that call naked. The covered call loses $19 if it goes to zero, a drop of 20 points. The naked $25 call doesn’t lose 19 points until the underlying hits $45 or 25 points higher. Within that price range, which is riskier? For equidistant moves in either direction, the covered call is riskier. However, above 45 it’s a different story.

There are other factors to be considered such as the market rising for longer periods than falling but those are decisions as to which strategy is more appropriate for the market you’re in. In the narrow confines of equidistant price movement in either direction, a naked call is less risky than a covered call.

If you really want to be clever, use vertical spreads instead of a B/W or a naked call, eliminating the bulk of the potential loss in either direction :->)

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