Selling Index Calls

The index short call strategy is a bearish strategy designed to earn from the premiums for selling the index call options with the hope that they expire worthless.

Index Short Call Construction

Sell 1 ATM Index Call

The options trader employing the index short call strategy expects the underlying index level to be below the call strike price on option expiration date.

Limited Profit Potential

Maximum profit is limited to the premiums received for selling the index calls.

The formula for calculating maximum profit is given below:

• Max Profit = Premium Received - Commissions Paid
• Max Profit Achieved When Index Settlement Value <= Index Call Strike Price

Unlimited Risk

As the index level could rise dramatically, there is virtually no limit to the loss sustainable should the index level rallies explosively.

The formula for calculating loss is given below:

• Maximum Loss = Unlimited
• Loss Occurs When Index Settlement Value > Index Call Strike Price + Premium Received
• Loss = Index Settlement Value - Index Call Strike Price - Premium Received + Commissions Paid

Breakeven Point(s)

The underlier price at which break-even is achieved for the index short call position can be calculated using the following formula.

• Breakeven Point = Index Call Strike Price + Premium Received

Example

XYZ Index is a broad based index representative of the entire stock market and its value in June is 400. Believing that the broader market will fall moderately in the near future, an options trader sells a six-month XYZ index call with a strike price of $400 expiring in December for a quoted price of $4.50 per contract. With a contract multiplier of $100, the premiums received for selling the index call option comes to $450.

Suppose XYZ Index rose to 420 in December and the DEC 400 XYZ index call expires in-the-money. At settlement value of 420, the DEC 400 XYZ index call option will possess an intrinsic value of $20 and upon assignment of this option, the trader is required to pay a settlement amount of $2000 ($20 x $100 contract multiplier). Taking into account the premium received for selling the index call option, which is $450, the trader's net loss comes to $1550.

Suppose XYZ Index went down to 380 in December and the DEC 400 XYZ index call expires out-of-the-money. At settlement value of 380, the DEC 400 XYZ index call option will expire worthless with zero intrinsic value. The trader's net profit is therefore equal to the amount received for selling the index call option which is $450.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

You May Also Like

Continue Reading...

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

Follow Us on Facebook to Get Daily Strategies & Tips!

Index Options Strategies

US Market Index Options

Index Options

Index Basics

Options Strategy Finder

Outlook on Underlying:
Arbitrage Bearish Bullish Neutral - Bearish on Volatility Neutral - Bullish on Volatility

Profit Potential:
Limited Unlimited

Loss Potential:
Limited Unlimited

Credit/Debit:
Credit Debit

No. Legs:
1 2 3 4