Short Call Option: Profit Calculator and Payoff Visualizer

What is a Short Call Option?

A short call option is an options trading strategy where a trader sells a call option, giving the buyer the right (but not the obligation) to purchase the underlying asset at a specified price (strike price) before or at expiration.

A short call option is an unlimited-risk, limited-profit trade. Because of this unlimited risk nature, this strategy is typically reserved for advanced traders.

Short call options are generally profitable when the underlying price:

• Remains unchanged
• Declines in value

The short call aligns with bearish to neutral trade market expectations for these reasons. It is a great, albeit risky, strategy for generating income from options. 

Naked Short Call

Selling a call option without having a counter long position is known as a naked short call. Since the underlying asset's price can theoretically rise infinitely, the potential loss on a naked short call is unlimited.

To reduce this excessive risk, many traders buy a call option with a higher strike price, creating a vertical spread, also called a bear call spread. Spreads limit risk and significantly lower the margin requirements compared to a naked short call.

Short Call: Payoff Diagram and Calculations

The short call calculator included in this article will show you responsive payoff diagrams. 

Here are the straightforward payoff calculations for the short call options trading strategy:

Max Profit

• Formula: Premium received
• Explanation: The profit is capped at the premium collected, achieved when the underlying price stays at or below the strike price at expiration.

Max Loss

• Formula: Theoretically unlimited
• Explanation: Losses can grow infinitely as the underlying price has no upper limit.

Breakeven Point

• Formula: Strike price + premium received
• Explanation: Losses begin when the underlying asset price rises above the strike price by an amount greater than the premium collected.

Understanding the concept of an option's moneyness is important for understanding the conditions under which short call options profit. The moneyness state directly impacts the profit profile of a short call option.

Short Call Option: Moneyness

Like all options, short call options can exist in one of three moneyness states. While most short call options are inherently neutral to bearish, their moneyness state determines the extent of their bearishness or neutrality.

Out-of-the-money (OTM)

Out-of-the-money (OTM) short call options have a strike price higher than the current stock price. These options are slightly bearish to market neutral, as the underlying price must remain below the strike price to avoid moving in the money and causing potential losses.

Selling OTM calls offers a smaller option premium but is more likely to expire worthless, making them a common choice for traders expecting a neutral or slightly bearish market.

At-the-money (ATM)

At-the-money (ATM) short call options have a strike price equal to the underlying asset's current price. These options are moderately bearish and suited for traders expecting minimal upward movement or a slight decline in the underlying price.

Since ATM options have no intrinsic value, their entire premium is comprised of extrinsic value. 

In-the-money (ITM)

In-the-money (ITM) short call options have a strike price lower than the current stock price. These options are highly bearish, requiring a significant downward move in the underlying asset's price to be profitable.

Selling ITM short calls can be profitable for traders expecting a reversal or significant drop in the underlying price, such as a stock, ETF, or index. However, the high premiums collected come with more significant potential losses if the price rises.

Short Calls and Time Decay

Most traders know that buying single options is generally a losing strategy over the long run, especially for out-of-the-money (OTM) options. This is primarily due to time decay, or "theta."

The price of ATM and OTM options is entirely made up of extrinsic value, as these options lack intrinsic value.

Extrinsic value is largely driven by time value or theta. As time passes and the underlying price remains unchanged, the probability of an ATM or OTM option expiring ITM decreases. This reduction in odds causes the option's price to erode—a process known as time decay, or "theta."

For this reason, most professional traders prefer selling options over buying them. However, selling options naked comes with significant risk, particularly in cases where the underlying price moves dramatically against the position, potentially leading to unlimited losses.

Short Call Options: Assignment Risk

Option sellers need to be aware of assignment risk when applicable.

Options give the buyer the right, but not the obligation, to acquire the underlying asset at the strike price. If an option is exercised, the short must deliver the underlying asset. The chances of an option being exercised increase when:

• The option is in-the-money (ITM), with a higher probability the deeper ITM it is.
• The expiration date is approaching, which reduces time and increases intrinsic value.
• The option's value is primarily intrinsic
• A dividend is approaching (American-style options)

However, short option sellers can eliminate this risk of early assignment by trading ‘European-style’ options. Let’s next learn about the different types of options contracts!

Types of Options Contracts

There are two different types of option contracts: American-style and European-style.

American Style Options

Most stock and ETF options are American-style, meaning they allow for early exercise. This flexibility exists because these options are tied to tradable underlying securities, like stocks or ETFs.

European Style Options

Most index options are European-style, meaning they can only be exercised at expiration. This structure is common for indices like SPX (S&P 500 Index) and NDX (Nasdaq-100 Index), which do not have an underlying tradable security.

Because these options are cash-settled, early exercise would provide no benefit. Instead, the final settlement value is determined at expiration based on the index level at that time.

Short Calls and Margin Requirements

Selling options naked requires a significant margin, so it's crucial to consider the opportunity cost of your trade. 

For example, if you sell a call option for a $0.35 premium with 5 months until expiration, but the trade requires $6,000 in margin, it’s worth asking: what could you have earned by investing that $6,000 in T-bills at the risk-free rate instead? 

Margin requirements differ by broker, but generally speaking, the margin requirement for short calls is the greater of:

1. 20% of the underlying price minus the out-of-the-money amount, plus the premium received, or
   
   
2. 10% of the underlying price plus the premium received

Short Call: Real World Trade Example

Let’s say you are bearish on SPY (SPDR S&P 500 ETF Trust) and expect it to stay below its current levels over the next seven days.

You pull up an options chain and sell the 609 strike price OTM call option on SPY, as shown on the TradingBlock platform below.

Here are our trade details:

Initial Trade Details:

• Symbol: SPY
• Underlying Price: $607.59
• Strike Price: 609
• Option Price (Credit Received): $2.66 ($266 total)
• Days to Expiration (DTE): 7 days
• Net Margin requirement: $12,000

Four days have passed, and SPY has made a slight upward move to $608.50, still below the strike price.

What happened to our short call?

• Symbol: SPY
• Underlying Price: $607.59 →  $608.50 (+0.91)
• Strike Price: 609 (unchanged)
• Option Price: $2.66 → $1.21
• Days to Expiration (DTE): 7 days → 3 days
• Net Margin requirement: $12,000

Result:
The option premium has dropped from $2.66 to $1.21. As the seller, you can now buy back the option at $1.21, locking in a profit of $1.45 per contract ($145 total).

Why did this happen?
The small price increase in SPY was not enough to make the option move significantly closer to being ITM. Additionally, time decay (theta) reduced the option's extrinsic value as expiration approached, working in your favor as the seller. Here’s how the theta ate away at the price of our option over the days:

Note that this example assumes implied volatility remains constant. If SPY experienced higher volatility, the price of all options would increase. Interest rates and other market conditions also play a role but to a smaller degree.

Short Calls: Delta and Gamma

Short calls are sensitive to the Greek's delta and gamma, which measure price change and acceleration.

• Delta: Represents the rate of change in the option’s price for every $1 change in the underlying asset. Short calls have a negative Delta, meaning they lose value as the underlying price rises.‍
• Gamma: Measures the rate of change in Delta. Short calls have negative Gamma, so the risk increases exponentially as the underlying price moves against the position.

Explore Options With Virtual Trading

With TradingBlock’s Virtual Trading platform, you can trade options in a simulated environment. Check it out below today!

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⚠️ When selling a short call, risk management is crucial. Beyond the premium received, remember to account for commissions and fees, as they can significantly affect your net profit or loss. These costs should always be factored into your trading strategy. Please read Characteristics and Risks of Standardized Options before trading options.