Short Call Options Strategy Explained: Learn the Basics

A short call is a neutral to bearish options trading strategy that involves selling a call contract at a strike, typically at or below the current market price of a stock. The short call strategy also goes by other names, including bear call, naked call, and uncovered call.

Selling a naked call can be an alternative method of gaining bearish exposure to a particular underlying without shorting shares outright. Investors can sell to open out-of-the-money (OTM) or in-the-money (ITM) call(s) when establishing a short call position.

The ideal scenario when selling OTM uncovered calls is when the underlying does not breach or approach the short call’s strike price over the life of the trade and expires worthless. This allows the call to erode all of its extrinsic value by the expiration of the contract to yield maximum profit. However, when selling ITM naked calls, investors require a much larger downward price move so the option goes OTM and, ideally, expires worthless to yield a maximum profit.

In-the-money (ITM) calls are usually worth more than out-of-the-money (OTM) calls because they have intrinsic value and usually extrinsic value as well. Intrinsic value describes an option's immediate value for being ITM, which is the difference between the underlying price and the strike. An option's extrinsic value depends on several factors, such as time left to expiration and implied volatility. Although short ITM calls are usually more valuable than short OTM calls and may yield greater profits if the underlying moves down, reducing the value of the call itself, they come with greater risks.

Since short calls synthetically provide bearish exposure to a specific underlying, there may be additional risks associated with holding a short call position. While ITM options generally have higher (early) assignment risk than OTM options, some situations can increase the chance of early assignment on a short call, such as dividend risk if the underlying pays one, hard-to-borrow fees when there is heightened short interest, and theoretical unlimited losses of holding short shares after assignment. When an investor is short a call, it can convert to 100 short shares per contract before expiration if assigned, and the investor will assume the risk of short shares after assignment. This risk still applies to short calls that are not assigned as it represents the theoretical equivalent of 100 shares of short stock.

Like other short option strategies, time decay can help erode an OTM call option's value when the underlying price remains stable and doesn't approach the short call option's strike price.

Maximum profit occurs when a short call remains out of the money until expiration and expires worthless. Investors do not have to wait until the contract expires to close the position. Profit can also occur when an investor buys (covers) the short call back before it expires at a price lower than it was sold for. On the contrary, an investor can incur a loss when buying back a short call at a higher price than it was sold for.

Uncovered calls are only allowed in a margin account with the highest trading level, "The Works." Eligible IRA holders must enable "IRA The Works" to sell naked calls in an IRA. Naked or uncovered calls are held at higher margin requirements in an IRA than in a non-IRA. Additionally, IRAs cannot establish or maintain a short stock position if assigned. As a result, investors assigned short shares in an IRA will receive a Short Restricted [Margin] Call and must close the position after assignment. Please visit the tastytrade Help Center to learn more about Short Restricted Strategy (SL) Calls.

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Expiration Risk for Naked Calls

Options that expire in the money by $0.01 or more are auto-exercised, resulting in an assignment of 100 short shares of stock for each ITM short call.

Moreover, any options strategy involving short options, including a naked short call, may face after-hours risk on the day of expiration. In summary, although the short call may have expired OTM based on the closing price of the underlying, an OTM short call option can become ITM based on any extreme upward price movement after the market close, resulting in an unexpected assignment of short shares. As a result, the investor would assume the risk of 100 short shares per contract assigned, which theoretically has unlimited risk. The only way to eliminate after-hours risk is by closing any short options positions before expiration.

It's crucial to have a plan, like closing or rolling the position before expiration, if a short share assignment is not part of your strategy. Please visit the tastytrade Help Center to learn more about Expiration Risk, including more about pin risk and after-hours risk.

A short/naked call can achieve a maximum profit if it expires OTM and is worthless, as illustrated in the flattened green shaded area below. Naked calls can potentially remain profitable if the underlying remains below the breakeven price, as shown where the red and green zones converge on the x-axis. This is why the short call is said to be neutral to bearish, as opposed to a purely bearish strategy like shorting shares of stock. When selling options, the max profit on the strategy is the initial credit received. A short call will incur losses if the call closes above the breakeven zone at expiration, which is defined as the short call strike plus the credit received upfront for selling the call contract. Please be mindful of assignment risk for ITM short option as assignment can happen at any time up to the expiration date. As always, manage your options positions closely.

XYZ trading @ $45

• Sell to Open -1 XYZ 50-strike call @ $4 credit

Collect a $4 credit ($400 total)

Using the Strategy Menu

1. Enter a symbol.
2. Navigate to the Trade tab.
3. Go to the Table mode.
4. Click on an expiration date to expand.
5. Click the Strategy menu.
6. Locate the option strategy and (from left to right) click each column to display Short, Call, and Go.
7. The short call will appear in the expanded expiration as a red bar. Drag the bar up or down to adjust the strike. 
8. Go to the order ticket to determine the quantity, price, time-in-force (TIF), etc., before clicking Review and Send. Review everything including commissions and fees before sending the order.

Building it Manually

1. Enter a symbol.
2. Navigate to the Trade tab.
3. Go to the Table mode.
4. Click on an expiration date to expand.
5. Click the bid price on the strike you want to sell. The short call will appear in the expanded expiration as a red bar. Drag the bar up or down to adjust the strike.
6. Go to the order ticket to determine the quantity, price, time-in-force (TIF), etc., before clicking Review and Send. Review everything including commissions and fees before sending the order.