John Jagerson

A Closer Look at Shorting Calls

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In addition to the benefit of melting time value when you are shorting or selling a call, a short option position is flexible. This flexibility allows you to place the call's strike price and your trade's breakeven points above resistance levels you might see in your technical analysis. This can increase the probability of a successful trade outcome.

Selling a call is a bearish trade because you are selling the call first and hoping to buy it back later for a cheaper price (or let it expire worthless) when the underlying stock drops.

You should note that most traders feel that selling calls is a higher risk strategy than selling puts. Most stocks and market indexes have a long-term tendency to trend up. That makes most bearish trades less likely to end profitably. This increases the importance of evaluating trends and finding the weakest stocks to trade.

In the chart below, you can see Merrill Lynch (MER) in a significant downtrend. That is exactly the kind of trend you want to see as a call seller.

Assume that you decided to sell the first out-of-the-money call at the $40 strike for a premium of $220. As long as the stock's price stays below the strike price, you will get to keep the entire premium for a maximum profit of $220 per contract.

A closer look at this trade can help you to visualize what I mean when I say that selling options gives you some flexibility.