Short Call Option: Benefits of Trading Short Call Option with Caution: Options, Futures, Derivatives & Commodity Trading

Short Call Option: Benefits of Trading Short Call Option with Caution

This article discusses the benefits of Trading Short Call Options and reasons for Trading Short Call
As covered in our past article on How to Trade a Short Call? Payoff Charts Explained, we raised a question that a short call option offers unlimited loss with limited profit. Then why do people trade on such dangerous positions? We'll answer this question.
It is a well known fact that stock prices or index prices move. They never stay steady. These stocks and indices make the underlying for options trading. Since they move, the options prices and the exercise of options is determined accordingly. It is also known that most of the options expire worthless, that is Out of the money (See Moneyness of Options - OTM, ATM, ITM Options). It is this feature that short options traders try to exploit. Short Call Option
Let's see the reasons for Short Option Trading Positions:

1) Square off of a Buy Option Position: This is the simplest reason for someone to short sell an option. You had bought an option at $5. Now due to the underlying price movements, the price of the option has gone by to $7. So you sell back you option (square off your option position) and book your $2 profit.

2) When you have a bullish view, but do not have sufficient money to buy a Put Option: This is the typical case of leverage trading. You are very sure that the price of the underlying is going to fall. So you have 2 choices - buy a Put Option or Short a call Option. But buying a put option will require money, since you are buying something. What if you dont have sufficient money, then you SELL or Short Call Option.

3) Time Decay works in favour of Short Options: This is THE MOST IMPORTANT reason why option traders short calls and puts. As explained in the article Options Time Decay: Explained with Examples, the value of option price comes from 2 parts - intrinsic value and time decay value.
As time passes by, the time decay value of an option keeps on reducing, as the time to expiry keeps on reducing with every passing day. Hence, over a period of time, the time decay value is lost from the pricing and hence the option price automatically comes down. So even if the underlying price stays where it is, the time decay ensures that the option price does come down.
The short option traders attempt to benefit from this option time decay. The loss of time decay is bourne by the buyer of the option.
It is usually said that most of the options expire worthless - i.e. they are not exercised at all. In such cases the shorters of options benefit as they get to keep the entire premium they get from option selling.

However, a note of caution here. The time decay in option may not be that big compared to effect of the underlying price movement. i.e. option price is more sensitive to underlying price movement, rather than the time decay. So one must understand the risks well and take options trading positions accordingly as per their risk appetite. Its always better to have clear view about the stop loss points and profit targets
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