Guide to Writing Call Options: What You Should Know

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Editor's Note: Options are not suitable for all investors. 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. Please see the Characteristics and Risks of Standardized Options.

Writing a call option refers to selling a call option contract to a buyer in exchange for a premium, or fee. The writer agrees to sell the option’s underlying stock at a fixed price (the strike price) if the buyer exercises the option within a set time frame.

There are two ways to write a call option — sell a covered call or sell a naked call.

•   Writing a covered call means selling an option on an underlying stock that you own.

•   Writing a naked call means selling an option on a stock you do not currently own.

The biggest difference between these two paths is the risk profile. Your risk with covered calls is that you may miss out on some of the upside gains if the stock’s price goes above the strike price of your call option.

When you sell a naked call, however, you have no risk protection and theoretically unlimited risk.

What Are Calls?

To understand writing call options, it can be helpful to consider the basics of call vs. put options: When you buy a call option at a specific strike price, you have the right (but not the obligation) to purchase the underlying stock at the strike price of the option over a given time period.

Buying a put gives you the right, but not the obligation, to sell the underlying stock at the strike price before expiration.

To learn how to trade options, it’s important to understand the differences between calls and puts, when to buy or sell options, and how to develop options strategies to minimize risk. When you buy an option, your maximum risk is capped at the amount of the premium, or fee, that you initially paid for the option. But when you write a call option or put option, your risk can be substantial or theoretically infinite.

Writing Call Options

Writing call options is similar to writing put options in that you initially sell the option for a premium. When you write a call option, you are creating a new option contract that allows the buyer the right to buy the stock at the specified strike price at any time on or before the expiration date.

When you write a call option, the option holder may exercise their right to buy the stock at the strike price at any time. In practice, early exercise is rare and typically occurs when the option is deep in-the-money, particularly if there is little time value remaining before expiration.

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Writing Call Option Strategies

There are different options trading strategies you could use when writing call options, depending on whether you have a bullish or bearish outlook for a given stock. Here are two of the most common call writing option strategies:

Writing Covered Calls

One common options strategy is writing covered calls. A call is considered a “covered” call when you also own at least 100 shares of the underlying stock. Writing covered calls is a popular income strategy if you think that the stock you hold will move within a specific range. You then might write a covered call with a strike price a little above the expected price range.

When you write covered calls, you will collect an initial premium since you are the seller of the option contract. Your best case scenario is that the underlying stock will close below the strike price of the call option at expiration. That means that the call will expire worthless, and you will keep the entire premium. If the stock closes above the strike price at expiration, you will be forced to sell your shares of stock at the strike price. This means that you may miss out on any additional gains for the stock.

Writing Naked Calls

Understanding what naked calls are is essential for options traders. A naked call is written when the seller does not own the underlying stock, creating the potential for unlimited losses. Unlike covered calls, writing naked calls comes with significant risk. Since a stock has no maximum price, you have unlimited exposure. The more a stock’s price rises above the strike price of the call option, the more money you will lose on the trade.

Due to the potential for unlimited losses, writing naked calls is considered a high-risk strategy and is typically used by traders with significant options experience or investors with a high risk tolerance. It’s important to understand these risks before writing naked calls, and you should also have a plan for what you will do if the stock moves unfavorably.

Writing Call Options Example

To understand the difference between writing covered calls and naked calls, here are two examples.

Covered Call Example

Say that an investor owns 100 shares of a stock with a cost basis of $65. Expecting the stock to trade between $60 to $70, the investor writes a covered call with a one-month expiration and a strike price of $70, collecting $1.25 in premium, or $125 ($1.25 x 100 shares).

If the stock closes below $70 at expiration, the investor retains their shares and the full $125 premium. Since the stock remains in their portfolio, another covered call could be written in the following month, which may generate additional premium income.

If the stock rises to $75 by the expiration date, the writer will be obligated to sell 100 shares of stock at the strike price of $70. Because the investor already owns 100 shares, they would be assigned. A broker facilitates the sale at $70/share, resulting in a $500 opportunity loss versus the $75 market price.

Naked Call Example

Assume that an investor has a bearish outlook on a stock that is currently trading at $100 a share. The investor decides to execute a naked call, meaning writing a call option for stock they don’t already own. They sell a call option with a $110 strike price for a premium of $4.25, collecting $425 upfront ($4.25 x 100 shares per the option contract). If the stock closes below $110/share at expiration, the contract expires worthless, allowing the investor to keep the entire $425 option premium.

If the stock price rises to $250 per share, for example, the seller would need to buy 100 shares for $25,000 and then sell them at a strike price of $110 per share to the buyer, incurring a $14,000 loss. This loss is offset slightly by the $425 premium initially collected.

The Takeaway

Writing call options may serve as an income-generating options trading strategy under certain market conditions. Writing covered calls on stocks already held in a portfolio may provide additional income, but limits profit potential if the stock price rises significantly.

A naked call involves writing calls on stocks the seller does not own. This strategy could result in substantial losses, depending on price movement, making risk management essential.

FAQ

Is writing a call option the same thing as buying a put?

Writing a call option and buying a put are different strategies with distinct risk profiles. An investor writing a call collects a premium but may be required to sell shares of the underlying asset at the strike price if assigned. A put gives the buyer the right to sell shares at a set price. Put buyers risk only the premium paid, whereas uncovered call writers face significant risk, as losses can increase indefinitely if the stock price continues to rise.

Does a writer of a call option make an unlimited profit?

No, a call option’s writer’s profit is capped at the premium collected. If the stock closes below the strike price at expiration, the option expires worthless, and the writer keeps the full premium. Unlike buyers, call writers do not benefit from stock price gains beyond the premium received.

How are call options written?

Writing a call option is another way to say that an investor is selling a call option. The call option seller receives a premium in exchange for giving the buyer the right (but not the obligation) to buy 100 shares of the stock at a predetermined strike price before expiration. If the option is exercised, the seller must deliver shares at the strike price, regardless of the market price at the time.

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