What’s the Difference Between Short Calls and Long Calls?
Every time a call option contract transaction takes place there is a seller and a buyer. The seller is said to have gone short the calls and the buyer is long the calls. “Short calls” and “long calls” are simply shorthand for these two positions and strategies.
Short calls are a bearish options strategy used to profit from an expected sideways to downward price action on a security. On the other hand, a long call is a bullish options strategy that aims to capitalize on upward price movements on an asset such as a stock or exchange-traded fund (ETF).
Short calls are the opposite strategy to long calls and their potential payoffs reflect that. Long calls have the potential to be unlimited in gain, and short calls the maximum gain is the premium.
What Are Short Calls?
“Short calls” is shorthand for pursuing the strategy of selling a call option.
Short call sellers receive a premium when the call is sold. The seller hopes to see a decrease in the underlying asset’s price to achieve the maximum profit.
It is also possible for the seller to profit if the underlying asset price stays the same. Options prices are based on intrinsic value (the difference between the strike price and the asset price) and time value.
If the asset price remains stable, intrinsic value will also be stable. However, as the option nears expiration the time value will drop to zero due to theta decay.
Furthermore, there are two types of short calls, naked and covered calls. Short calls are “naked” when the seller does not own the underlying asset. Short calls are “covered” when the seller owns the underlying asset at the time of sale.
Short calls have a fixed maximum profit equal to the premium collected and losses are undefined. Theoretically, a stock could rise to infinity, so there is no cap on how high the value of a call option could be.
Therefore short calls can be highly risky. For this reason, traders should have a risk management plan in place when they engage in naked call selling.
Short Call Example
It’s helpful to see an example of a short call to understand the upside reward potential and downside risks involved with such a strategy.
Suppose your outlook on shares of XYZ stock is neutral to bearish. You think that the stock, currently trading at $50, will trade between $45 and $50 in the next three months.
A plausible trade to execute would be to sell the $50 strike calls expiring in three months. We’ll assume those options trade at $5. The breakeven price on a short call is the strike price plus the premium collected.
In this example, the breakeven price is thus $50 plus $5 which is $55. You profit so long as the stock is below $55 by the time the options expire but will experience losses if the stock is above $55 by expiry.
Two months pass, and the stock is at $48. The calls have dropped in value thanks to a minor share price decline and since there is less time until expiration. The drop in time value relates to decaying theta, one of the option Greeks, as they’re called. Your short calls are now valued at $2 in the market.
Fast-forward three weeks, and there are just a few days until expiration. The stock has rallied to $49, but the calls have actually fallen in value. They are now worth just $1. Time decay has eaten away at the value of the calls — more than offsetting the rise in the underlying shares. Time decay becomes quicker as expiration approaches.
You choose to buy-to-close your options in the market rather than risk a late surge in the stock price. Most options are closed out rather than left to expire (or be exercised) as closing options positions before expiration can save on transaction costs and added margin requirements. You cover your short calls at $1 and enjoy a net profit of $4 on the trade ($5 collected at the trade’s initiation and a $1 buy back to close the position).
Pros and Cons of Short Calls
| Pros of Short Calls
|
Cons of Short Calls
|
| Benefits from time decay |
Unlimited risk if the underlying asset rises sharply |
| Can be used in combination with a long stock position to generate extra income (covered call) |
You may be required to deliver shares if the options holder exercises the call option |
| The underlying stock can be sideways to even slightly higher and you can still profit |
Reward is capped at the premium you received at the onset of the trade |
Finally, user-friendly options trading is here.*
Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.
What Are Long Calls?
Long calls are the opposite strategy to a short call. With a long call, the trader is bullish on the underlying asset. Once again, a key piece of the options trade is the timing aspect.
A long call benefits when the security rises in value, but it must do so before the options expire.
Long calls have unlimited upside potential and limited downside risk. A long vs short call differs in that respect since a short call has limited profit potential and unlimited risk.
A long call is a basic options strategy that is often a speculative bullish bet on an underlying asset. It’s a good options strategy for those just starting out since there is a limited loss potential and the strategy itself is not complicated.
Long Call Example
Buying a long call option is straightforward. Long calls vs short calls involve different order types. With long calls, you input a buy-to-open order and then choose the calls you wish to purchase.
You must enter the underlying asset (often a stock or ETF, but it could be an option on a futures contract such as on a commodity or currency), along with the strike price, options expiration date, and whether the order is a market or limit order.
Suppose you go long calls on XYZ shares. The stock trades at $50 and you want to profit should the stock rise dramatically over the next month. You could buy the $60 strike calls expiring one month from now. The option premium — the cost to buy the option — might be $2. Because the call is out-of-the-money, that $2 is composed entirely of extrinsic value (also known as time value).
Since you are going long the calls, you want the underlying stock price to rise above the strike price by expiration. It’s important to know your breakeven price with a long call — that is the strike price plus the premium paid. In our example, that is $60 plus $2 which is $62. If the stock is above $62 at expiration, you profit.
After three weeks, the stock has risen to $70 per share. Your calls are now worth $13.
That $13 of premium is made up of $10 of intrinsic value (the stock price minus the strike) and $3 of time value since there is still a chance the stock could keep increasing before expiry.
A few days before expiration, the shares have steadied at $69. Your $60 strike calls are worth $10. You decide to take your money and run.
You enter a sell-to-close order to exit the position. Your proceeds from the sale are $10, making for a tidy $8 profit considering your $2 premium outlay.
Pros and Cons of Long Calls
| Pros of Long Calls
|
Cons of Long Calls
|
| Unlimited upside potential |
The premium paid can be substantial |
| Risk is limited to the premium paid |
You can be correct with the directional bet and still lose money if your timing is wrong |
| Is a leveraged play on an underlying asset |
There’s a chance the calls will expire worthless |
Comparing Short Calls vs Long Calls
There are important similarities and differences between a short call vs long call to consider before you embark on a trading strategy.
Similarities
Traders use options for three primary reasons:
• Speculation — Speculators often do not take positions in the underlying stock. Investors can buy a call and hope the underlying asset rises or they can sell a call and hope the asset price drops. Either way, the investor is taking a risk and could lose their investment, or more in the case of naked short calls.
• Hedging — Short sellers of stock may sometimes buy call options to hedge their stock positions against unexpected price movements.
• Generate Income — Covered short calls help to generate extra income in a portfolio. The seller sells a call that is out-of-the-money, collects the premium, and hopes the stock doesn’t rise to that strike price. However, the investor can also choose a strike that they would be happy to sell at such that, if the stock rises and the option is exercised, they are happy to sell their shares.
Differences
Long calls are a bullish strategy while short calls are a neutral to bearish play.
Potential profits and possible losses are the opposite in long calls vs. short calls. A long call has unlimited upside potential and losses are limited to the premium paid. A short call has an unlimited loss potential with a max profit that is simply the premium collected at the onset of the trade.
Time decay works to the benefit of an options seller, such as when you enter a short call trade. Time decay is the enemy of those who are long options.
When implied volatility rises, the holder of a call benefits (all else equal) since the option will have more value. When implied volatility drops, options generally become less valuable, which is to the option writer’s benefit.
It’s also important to understand the moneyness of a call option. A call option is considered in-the-money when the underlying asset’s price is above the strike price. When the underlying asset’s price is below the strike, then the call option is considered out-of-the-money.
A call writer prefers when the call is more out-of-the-money while a call holder wants the calls to turn more in-the-money.
| Short Calls
|
Long Calls
|
| Neutral-to-bearish view |
Bullish view |
| A more advanced options play |
A trade that is good for options beginners |
| Limited reward, unlimited risk |
Unlimited reward, limited risk |
The Takeaway
Long calls and short calls are two options trading strategies you can use to place a directional and timing wager on an underlying asset — often a stock or ETF. Buying calls is a bullish play while selling calls is a neutral to bearish strategy.
If you’re ready to try your hand at options trading online, You can set up an Active Invest account and trade options from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, but some fees apply, and members have access to complimentary financial advice from a professional.
With SoFi, user-friendly options trading is finally here.
FAQ
Are long calls better than short calls?
Long calls are not necessarily better than short calls. Using one versus the other depends on your outlook on how a security will move between now and expiration.
Long calls appreciate when the underlying asset rises in value. Short calls, on the other hand, are useful if you have a neutral to bearish view on a security. Short calls drop in value as time value erodes and when the underlying asset’s price falls.
Like long calls, it is important that your directional bet and timeframe line up with the calls you look to sell short.
How do short calls and covered calls differ?
Short calls are often naked positions. That means they traded outright without having an existing long stock position. Naked short calls are risky since there is unlimited loss potential should the stock rise.
Covered calls work by owning shares of a stock, then selling calls against that long stock position. Covered calls are a common options trading strategy whereby a trader looks to enhance a portfolio’s income by collecting a premium while the underlying shares trade sideways or decline in value.
The downside of covered calls is that your shares can get called away from you if the stock price rises above the strike price. Covered calls have the benefit of protecting the trader from unlimited losses since the long stock position offsets the short calls’ unlimited loss potential.
Photo credit: iStock/Prostock-Studio
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
SOIN0221023
Read more
