What is Call Writing?

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  • 19 Jul 2023

Options trading offers a diverse range of strategies to capitalize on market movements, and one such strategy is call writing. Call writing, also known as selling covered calls, is a popular options trading technique that allows investors to generate income while holding a particular asset in their portfolio.

Call writing is a trading strategy that enables investors to sell call options at a specific strike price in exchange for a premium. The strike price represents the predetermined price at which an underlying security or asset can be bought or sold on the expiration date of the options contract. The expiration date marks the end date when the options contract becomes void.

When an investor engages in call writing, they must receive the premium from the buyer of the call option. In this strategy, if the stock price rises, the buyer has the right to exercise the option and purchase the asset at the predetermined strike price that results in a loss for the call writer. Conversely, if the stock price does not increase, the call writer can earn a profit equal to the premium received.

Consider a scenario where a trader possesses 100 shares of ABC stock, currently valued at Rs.100 per share. Anticipating a sustained high stock price in the coming months, the trader decides to engage in call writing by selling a call option contract with a strike price of Rs.105 and a three-month expiration date. By doing so, the trader earns a premium income of Rs.300 (Rs.3 x 100 shares) for every 100 shares covered by the call option.

In this particular call writing example, the trader adopts a bullish outlook on the stock and get a premium for selling the call option. If, at the option's expiration, ABC's share price remains at or below Rs.105, the trader will be refunded the Rs.300 premium paid for the call option. However, if the stock price of ABC surpasses Rs.105, the call option buyer retains the right to purchase the stock from the trader at the predetermined strike price. In such a case, the trader would incur a loss but still have the Rs.300 premium received.

If you are considering call writing options, here are some commonly employed strategies to consider:

  1. Naked Call Writing: In this strategy, traders write call options without owning the underlying asset or stock. It carries the highest potential for loss since stock prices are not capped and can rise indefinitely.

  2. Collar Options: With this call writing options strategy, you purchase a put option while simultaneously writing a call option. The put option is a hedge against potential losses resulting from the call option.

  3. Covered Call: This strategy involves writing call options on a company's stock that you already own. It is suitable when you anticipate that the underlying stock's price will either drop or remain stable over a short period. While a covered call helps limit losses, it may also restrict potential profits.

  • As the writer of the call option, you will receive a premium payment upon entering the contract. It's important to note that this premium is non-refundable, even if the buyer decides not to buy the underlying securities.

  • Another advantage is the flexibility it provides. You have the freedom to close the contracts at any time before the expiration date, allowing you to adjust your position as needed.

  1. Volatility in Stock Price: A company's stock price fluctuations can significantly impact options trading and call writing. When volatility is high, the premiums for call options tend to increase. This is due to the increased uncertainty, indicating a higher probability of price movement in either direction.

  2. Market Sentiment: The prevailing market sentiment plays a crucial role in determining the potential success of a call writing option. In a bullish market, call options are generally more expensive, offering better profit opportunities for the writer. Conversely, in a bearish market, call options are typically cheaper, resulting in lower potential profits for the writer.

  3. Interest Rates: Interest rates prevailing in the market can influence stock prices, consequently affecting the outcome of call writing options. Changes in interest rates can have a cascading effect on stock prices, impacting the profitability of call writing strategies.

  4. Trend in Share Price Movement: The trend in stock price movement is a significant factor in determining the success of call writing options. If a company's share price exhibits an upward trend, call option premiums tend to be higher. Conversely, a decline in the stock price will result in lower premiums for call options.

To Sum Up

If you plan to engage in derivatives trading, consider using call writing options as an effective method to hedge your portfolio. By selling options, you can protect against losses using the premium amount, even if the buyer chooses not to purchase the contract. Nonetheless, conducting comprehensive research is essential to maximize profits.

FAQs

Call writing refers to selling call options on a particular security or asset you already own.

The primary concern lies in forfeiting potential stock appreciation in return for the premium. If a call option is written and the stock experiences a significant surge, the writer can only reap the benefits of the stock's appreciation up to the strike price, but no further.

When writing a call option, an individual sells the call option to the holder and becomes obligated to sell the shares at a predetermined strike price.

Call writing is a bullish strategy. On the other hand, put writing is a bearish approach.

Call writing, in simple terms, involves selling a call option contract. The perspective of a call writer typically reflects a bearish or range-bound outlook. The call writer realizes profits if, at expiration, the spot price is below the breakeven point. It's important to note that the profit potential for a call option writer is constrained to the premium received from selling the option.

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