How to Write a Call Option

To learn how to write a call option, first understand that the process involves selling the option contract. This is called “writing” because the seller of the option contract writes down the terms for the buyer. In another sense, the seller is the one making the promise to buy the underlying security, so he writes the promise down. When you write a call, you are promising to buy a set amount of the underlying security at a set price for a set period.

Naked versus Covered Calls

The difference between a naked call and a covered call is that when you write a covered call, you sell the call at some point after you have purchased the underlying security. You have agreed to sell the underlying security under the terms of the option contract, but you are “covered” in the sense that if the option is exercised, you do not have to go to the open market to acquire the security.

The maximum profit you will receive is the premium you receive for the contract. The maximum loss when writing covered calls is limited to the potential negative performance of the underlying security.

In the case of a naked call, the maximum loss is unlimited. You do not already own the security, so as the price rises, the amount it will cost you to buy that security in the open market is unlimited. These calls are referred to as naked because there is no cover if the underlying security spikes higher—you are exposed.

How to Decide

When making any investment decision, you need to consider your tolerance for risk relative to your appetite for reward. Covered calls carry far less risk than naked ones, but you have to dedicate far more capital to a covered call writing program. These programs are usually employed when you have a reason to own the underlying security outright or have been an owner for an extended period. Every investor has a different level of risk tolerance, and it is important for you to make a realistic assessment of where yours lies before deciding which strategy to follow.

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