Call options give you the right, but not the obligation, to buy at a specific price (strike price) by a predetermined date (expiration date). Option contracts are derivatives based on the value of underlying securities such as stock. They usually represent 100 shares of the underlying security.
Typically a call gives you the opportunity to profit from price gains in the underlying stock. But you can also sell a call option without ever owning it in the first place. In this case, when selling a call you want the price of the underlying stock to stay the same or fall.
Selling a Call Option
On this Flow strategy we set the market projection to a negative number, expecting the price of the underlying stock (QQQ Stock) to fall. Notice QQQ 295 Call is in the red, yet our Strategy is in the green. Remember, when you buy a call and the stock price drops you’re in a loss, yet if you sell a call you’ll project profits.
Let’s get into the details:
- QQQ = Stock Ticker of Underlying Stock
- 295 = Strike Price
- Call = Call Option (expecting QQQ Stock to fall or stay the same when selling a call)
- 2021-02-12 = Expiration Date
Options are derivates of a stock, and QQQ is the underlying stock. The strike price of 295 shows the value you project the price to be in the future. You think the price of QQQ Stock will be less than or equal to $295 by the expiration date.
Closing a Call Option
Exiting BEFORE Expiration:
When you buy a call option (remember, you sold first now are buying meaning you’re paying it back) before it expires you can gain a profit if the value of your stock option is less than what you paid for it (stock price < buy-in price).
In our Flow example, we could pay back QQQ 295 Call Option on Feb 12 (in 2 days), giving us a 13% profit.
Exiting AFTER Expiration:
If you keep the call option until after expiration two things can happen depending on if it’s out-of-the-money or in-the-money.
Out-of-the-money means the strike price of the call option is higher than the current price of the stock (strike price > stock price). In this case, the option is worth $0 so you just earned 100% of what you invested.
Hear me out. In a normal scenario you buy low sell high, except here you’re selling first. That’s not a normal scenario. You’re trying to sell high buy low. Same concept and same outcome, just inverting the order.
When you sold you have unrealized profits of X (price), then to realize those profits you paid back at current price (price at expiration in this case). The lower the amount you have to pay back, obviously the better. Let’s pay back $0!
In our Flow example, if we were out-of-the-money at expiration we would have seen the strategy line on the chart change from in green to red. This means the stock price changed to being greater than the strike price. AI Intelligence updates Flow charts by the minutes to show the most accurate predictions.
In-the-money means the strike price of your call option is equal or less than the current price of the stock (strike price ≤ stock price). Your call options will convert to shares of the underlying stock automatically. But instead of owning the stock at expiration your broker will execute a sell of the stock at the strike price.
In our Flow example, if we were in-the-money at expiration we would have seen the strategy line either go further in the green, or stay about where it’s at currently. So the stock price either is the same as the strike price or even lower.
To make options even more complicated you sell a call option before ever buying it. Investors sell calls to protect against loss when they’ve purchased a stock falling, when they bought a call option that is losing, or even when they’re simply expecting the underlying stock to not do well in the market.
Buy low sell high is always the winning strategy. When selling first, you sell high and pay back low later.
IMPORTANT: Selling a call is one of the most risky ways to trades. The potential for loss is unlimited.
If the stock keeps rising your losses will keep rising. When you buy a call you can only lose as much as you put in, but when you sell a call you can lose an infinite amount. There is no limit to how much you can lose. It won’t end until you pay back the option you sold. It will keep diving until you take that loss.
So to win when selling options you need to not only choose the right call option (which is difficult enough), but you also need to be extremely confident in your projections of the market.
At InFabric we have a deep understanding of the risks and rewards surrounding options trading. We’re obsessed with making you money in any market volatility. Through our AI Intelligence feature we’ve achieved just that.
Create a Flow today. See just how easy options can be with the right tools!