Accepting Exposure   • 221
Downside: Fairly valued
Upside: Overvalued
Execute: Sell a call contract (short call); sell a call contract while 
simultaneously buying a call contract at a higher strike 
price (short-call spread)
Risk: Unlimited for short call; difference between strike prices 
and premium received (short-call spread)
Reward: Limited to the amount of premium received
Margin: Variable for a short call; dollar amount equal to the differ-
ence between strike prices for a short-call spread
The Gist
The market overestimates the likelihood that the value of a firm is above its pre-
sent market price. An investor accepts the overvalued upside exposure in return 
for a fixed payment of premium. The full amount of the premium will only flow 
through to the investor if the price of the stock falls and the option expires OTM.
There are two variations of this investment—the short call and the 
short-call spread. This book touches on the former but mainly addresses 
the latter. A short call opens up the investor to potentially unlimited capital 
losses (because stocks theoretically do not have an upper bound for their 
price), and a broker will not allow you to invest using this strategy except 
for the following conditions:
1. Y ou are a hedge fund manager and have the ability to borrow 
stocks through your broker and sell them short.
2. Y ou are short calls not on a stock but on a diversified index (such 
as the Dow Jones Industrial Index or the Standard and Poor’s 500 
Index) through an exchange-traded fund (ETF) or a futures con-
tract and hold a diversified stock portfolio.
For investors fitting the first condition, short calls are margined in the 
same way as the rest of your short portfolio. That is, you must deposit initial 
margin on the initiation of the investment, and if the stock price goes up, you 
must pay in variance margin to support the position. Obviously, as the stock 
price falls, this margin account is settled in your favor. For investors fitting the 
second condition, when you originally sell the call option, your broker should