Sell Call
Selling a call creates the obligation to sell the stock at the strike price. Why
is a trader willing to accept this obligation? The answer is option premium.
If the position is held until expiration without getting assigned, the entire
premium represents a profit for the trader. If assignment occurs, the trader
will be obliged to sell stock at the strike price. If the trader does not have a
long position in the underlying stock (a naked call), a short stock position
will be created. Otherwise, if stock is owned (a covered call), that stock is
sold. Whether the trader has a profit or a loss depends on the movement of
the stock price and how the short call position was constructed.
Consider a naked call example:
Sell 1 TGT October 50 call at 1.45
In this example, Target Corporation (TGT) is trading at $49.42. A trader,
Sam, believes Target will continue to be trading below $50 by October
expiration, about two months from now. Sam sells 1 Target two-month 50
call at 1.45, opening a short position in that series. Exhibit 1.3 will help
explain the expected payout of this naked call position if it is held until
expiration.