Selling Call Options
A call option gives the holder the right to buy an asset at a certain price (strike price) by a certain date (Expiration)
Payoff Diagram: Selling a call option
In this example we are using the following assumptions:
Sol Price: $100
SOL has had a strong recent uptrend , however Will thinks that there is no way the price of SOL will go above $150 (the strike price). He wants a way of profiting. Will might sell call options to accomplish this.
Will agrees to sell 1 call at $5, this allows him to collect the premium; Will will be paid $5 ($5 * 1). Lets look at the scenarios that could occur:
Scenario 1 (The price of SOL rises):
If the price of SOL keeps rising, this creates risk for Will. For example, if the price of SOL continues it's uptrend and goes to $175, the party who bought Wills short calls would be able to execute the option and purchase 1 SOL worth $175 each, for $150 each. In this scenario Will's loss is: $25 (underlying price - strike price) - $5 (the premium which is still kept by Will and helps offset some loss) = $20 loss per option.
Scenario 2 (The price of SOL stays the same):
If the price of SOL stays the same, Will would still have the $5 he sold 1 call of SOL for. He would profit $5 from the premium he received for selling the calls.
Scenario 3 (The price of SOL falls):
If the price of SOL heads lower over time, Will was right! He will profit by keeping the $5 premium he received from selling the call option
Why trade it? You think the price of the asset is going down or staying the same within a certain time frame.
What are the optimal conditions? Cheap volatility, bearish asset.
What is the cost: No cost! you get paid the premium to sell calls
Max Profit: The premium you get paid.
Max Loss: Unlimited, if the price of the underlying asset rises.
Breakeven at expiration: The strike price plus the premium.