Short Call
Writing a call obligates you to sell the underlying stock at the strike price any time until expiry if you are assigned.
Short Call
You short a call when you write (sell) a call that you don't currently own. There are two basic types of short calls covered and uncovered (naked).
Naked Call (Uncovered Call)
You could write a call if you think the price of the underlying stock is going to stay the same or fall (when you are neutral or bearish on the underlying stock).
Figure 5 shows the risk and return involved with writing a naked call with a strike price of $25 for a premium of $5. When you write a naked call the most you can make is the premium you receive for writing the call. However you are taking on unlimited risk if the underlying stock moves up.
Figure 5.
If the price of the stock rose to $40 by the expiry date the naked call position would be in a loss of $10 ($5 premium you originally received for writing the naked call + $25 the strike price which you are obligated to sell the stock for - $40 the price you would have to buy the stock for).
Covered Call
A covered call is when you own the underlying stock and you write a call. The call is covered because if you get assigned and have to sell the underlying stock it is OK because you already own it. If you think that a stocks price will stay the same or move up slightly you could write a covered call.
Figure 6 shows the risk and return involved with writing a covered call with a strike price of $25 for a premium of $3 at a time when the underlying stock is trading at $22. When you write a covered call there is a maximum amount that you can make. However you are taking on a lot of risk if the underlying stock falls.
Figure 6.
If the price of the underlying stock rose to $25 or higher by the expiry date the overall position would have a profit of $6 (this remains the same because any profits on the stock are offset by losses on the short call). If the price of the underlying stock fell to $10 your combined loss would be $9 ($10 the current price of the stock - $22 the price paid for the stock + $3 the premium received for writing the call).
A covered call position has the same risk reward profile as writing a naked put.
