Options trading has become one of the hottest topics in the Indian stock markets today. With more and more retail traders joining in, the buzz is usually around buying options, chasing big returns, and riding market swings. But there is another side of the story, one that often stays in the background yet is just as powerful, i.e., selling call options, also known as writing call options. If you have wondered how to write a call option, you have come to the right place. Check out this blog to know all about writing call options and devise a trading strategy plan.
Writing call options simply means selling a call option contract to another trader. In this case, the person who writes (or sells) the call options is giving the buyer the right to purchase a stock or index from them at a fixed price (called the strike price) before the contract expires. The writer collects a premium (the price of the option) upfront for taking on this obligation. The profit for the call writer is limited to this premium, but the risk can be unlimited if the stock price rises sharply. This will lead them to sell the stock at the strike price even if the market price goes much higher. Many traders write call options either as part of hedging strategies, income generation, or when they believe the stock will stay below a certain level. It’s a strategy that requires good market understanding, discipline, and proper risk management.
Option traders can use many ways of writing call options depending on their trading strategy and their risk appetite. A few basic strategies for writing call options are explained below.
This is the most basic and widely popular mode of writing call options. In covered call writing, the trader already owns the stock (or holds a long position in futures) and then sells a call option on the same stock. This way, the trader is ‘covered’ because if the option buyer chooses to exercise the contract, the seller already has the stock to deliver. The main advantage here is that the trader earns extra income through the premium received. However, the profit is capped because if the stock price shoots up beyond the strike price, the seller will still have to sell at that fixed strike price. This strategy is often used by investors who want to generate steady income from the stocks they already hold.
Understanding Covered Call Writing Using an Example
Shree owns 1 lot (100 shares) of Reliance Industries at Rs. 2,500 each. He expects the stock to move sideways and does not think it will cross Rs. 2,600 in the next month. To earn extra income, he sells a Reliance 2,600 call option at a premium of Rs. 30 per share.
Premium received - Rs. 30 * 100 = Rs. 3,000
Scenario A (Stock stays at or below Rs. 2,600) - The option buyer will not exercise the contract because buying at Rs. 2,600 does not make sense when Reliance is trading at or below that. The option expires worthless. Shree keeps the full premium of Rs. 3,000 as profit.
Scenario B (Stock rises above Rs. 2,600, say Rs. 2,700) - The option buyer exercises the option and buys Reliance from Shree at Rs. 2,600, even though the market price is Rs. 2,700. Shree still makes a profit on his shares (Rs. 100 per share from Rs. 2,500 to Rs. 2,600), plus the Rs. 30 premium. But he misses the additional Rs. 100 rally (from Rs. 2,600 to Rs. 2,700) because he is obligated to sell at Rs. 2,600.
Thus, Shree earns extra income from the premium, but his upside is capped. The risk is low since he already owns the stock.
Naked call writing happens when a trader sells a call option without owning the stock or having any position in it. This is considered riskier because if the stock price rises sharply, the seller may be forced to buy the stock from the open market at a very high price in order to fulfil the contract. The potential loss here is unlimited, while the gain is only the premium received. This strategy is usually taken up by experienced traders who have strong confidence that the stock or index will not move up much beyond the strike price.
Understanding Naked Call Writing Using an Example
Sharda does not own Infosys shares. Infosys is trading at Rs. 1,400. She strongly believes the stock will not rise above Rs. 1,450 during the month. Based on this view, she sells an Infosys 1,450 call option at a premium of Rs. 20 per share.
Premium received - Rs. 20 * 100 = Rs. 2,000
Scenario A (Stock stays below Rs. 1,450) - The call expires worthless because no buyer will exercise at Rs. 1,450 when the market is lower. Sharda keeps the entire premium of Rs. 2,000 as profit.
Scenario B (Stock rises to Rs. 1,550) - The option buyer will exercise the contract. Sharda must sell Infosys at Rs. 1,450 even though the market price is Rs. 1,550. To do this, she must buy Infosys from the market at Rs. 1,550 and sell at Rs. 1,450, losing Rs. 100 per share.
Loss = (Rs. 1,550 - Rs. 1,450) * 100 = Rs. 10,000
Net result = Loss Rs. 10,000 - Premium Rs. 2,000 = Rs. 8,000 loss
Here, the maximum profit Sharda can make is Rs. 2,000, but the loss can be very large if Infosys rallies.
In ratio call writing, a trader sells more call options than the number of shares or futures contracts they hold. For example, a trader may own 1 lot of a stock future but write 2 lots of call options. This generates higher premium income, but it also increases risk if the stock price rises sharply. The risk is greater compared to covered calls but slightly more controlled than naked calls because the trader still holds some position in the stock. Ratio call writing is generally used when traders expect the stock price to stay in a certain range.
Understanding Ratio Call Writing Using an Example
Ramesh holds 1 lot of HDFC Bank futures (equivalent to 500 shares) at Rs. 1,600. He expects the stock to remain stable. To earn more, he sells two lots of 1,650 call options at a premium of Rs. 25 each.
Premium received = Rs. 25 * 2 * 500 = Rs. 25,000
Scenario A (Stock stays below Rs. 1,650) - Both call options expire worthless, and Ramesh keeps the Rs. 25,000 premium as profit. His futures position also remains unchanged.
Scenario B (Stock rises to Rs. 1,700) -
Futures gain = (Rs. 1,700 - Rs. 1,600) × 500 = Rs. 50,000 profit
Loss on call options = (Rs. 1,700 - Rs. 1,650) * 500 * 2 lots = Rs. 50 * 1,000 = Rs. 50,000
Net result = Futures profit and option loss cancel out. He only keeps the premium of Rs. 25,000.
Scenario C (Stock soars to Rs. 1,800) -
Futures gain = (Rs. 1,800 - Rs. 1,600) * 500 = Rs. 1,00,000
Loss on call options = (Rs. 1,800 - Rs. 1,650) * 500 * 2 = Rs. 150 * 1,000 = Rs. 1,50,000
Net result = Rs. 1,00,000 - Rs. 1,50,000 + Rs. 25,000 premium = Rs. 25,000 loss
Thus, ratio writing gives extra premium income, but the risk increases sharply if the stock rallies too much.
A call spread involves selling a call option at one strike price and simultaneously buying another call option at a higher strike price. This reduces the overall risk compared to naked call writing, because the bought call acts as protection if the stock price rises too much. While the profit potential is limited (premium received minus the cost of the bought call), the losses are also capped. Many traders use this as a safer alternative to naked call writing.
Understanding Call Spread Writing Using an Example
Puja expects Nifty (20,000) to remain range-bound and not rise much above 20,200. To play safe, she uses a bear call spread as follows,
Sells Nifty 20,200 call for Rs. 50 premium
Buys Nifty 20,400 call for Rs. 20 premium
Net premium received = Rs. 30 * 50 (lot size) = Rs. 1,500
Scenario A (Nifty stays below 20,200) - Both calls expire worthless. Puja keeps the full Rs. 1,500 as profit.
Scenario B (Nifty rises to 20,300) -
Loss on short 20,200 call = (Rs. 20,300 - Rs. 20,200) * 50 = Rs. 5,000
Premium received = Rs. 1,500
Net result = Rs. 5,000 - Rs. 1,500 = Rs. 3,500 loss
Scenario C (Nifty rises sharply to 20,600) -
Loss on short 20,200 call = (Rs. 20,600 - Rs. 20,200) * 50 = Rs. 20,000
Gain on long 20,400 call = (Rs. 20,600 - Rs. 20,400) * 50 = Rs. 10,000
Net loss = Rs. 20,000 - Rs. 10,000 - Rs. 1,500 premium = Rs. 8,500 loss
This is the maximum possible loss, no matter how high Nifty goes.
A spread limits both profit and loss. It is safer compared to naked calls.
Writing call options can be a profitable strategy and requires a clear understanding for successful execution. Some of the typical or possible users of writing call options are explained below.
Traders or investors who hold stocks in their portfolio for the long term are ideal candidates for covered call writing. By selling call options on the stocks they already own, they can earn extra income in the form of premiums. For example, if someone owns Reliance or TCS shares and doesn’t expect a big price rally in the near term, they can write calls at higher strike prices to generate steady income. This is especially useful in sideways or slow-moving markets.
Call writing is best suited for those who believe that an index or stock will either fall or remain within a certain range. For example, if a trader expects Nifty to stay below 20,000 for the month, they can write Nifty call options above that level and collect the premium. If their view is correct, the option will expire worthless, and the premium becomes profit. However, if the market rallies sharply, the losses can pile up. Hence, confidence in the market view is critical.
Naked call writing, where the trader sells calls without owning the underlying stock or futures, is extremely risky. It should only be attempted by highly experienced traders who have sufficient margin, discipline, and the ability to exit quickly if the trade goes wrong. This strategy is often used by seasoned traders who track market trends closely and have stop-loss levels in place.
It is important to note that beginners who are just entering the stock market should be careful with call writing. Since the risk can be unlimited, they should first gain experience in simpler strategies, like covered calls or spreads, before attempting riskier trades. Without proper knowledge and risk control, naked call writing can lead to heavy losses in a short time.
The pros and cons of writing call options are essential aspects for a thorough understanding of writing call options. The risk awareness and the benefit of this strategy allow traders to execute informed trading strategies, thereby improving the chance of success. A few pros and cons of writing call options are,
Writing call options can be a powerful tool for traders when used with the right strategy and risk control. It offers steady income through premiums, works well in sideways or mildly bearish markets, and can even act as a hedge for stockholders through covered calls. However, traders must remember that while the profit is limited, the risk can be unlimited in naked call writing. Traders need to be adept at close monitoring of the market, as well as have a sufficient margin for efficient trading.
This article talks about an important aspect of options trading that can be tricky yet profitable when executed correctly with sufficient market knowledge. Let us know your thoughts on this topic or if you need further information on the same.
Till Then, Happy Reading!
Read More: What is the difference between In the Money, At the Money and Out of the Money Options
Marisha Bhatt is a financial content writer @TrueData.
She writes with the sole aim of simplifying complex financial concepts and jargon while attempting to clarify technical and fundamental analysis concepts of the stock markets. The ultimate goal is to spread vital knowledge and benefit the maximum audience. Her Chartered Accountant background acts as the knowledge base to help clarify crucial concepts and create a sound investment portfolio.
what happens if call writing contiously increase
If call writing keeps increasing, it often indicates that traders expect the market to face resistance around that level. It is a sign that many believe the price may not rise much beyond that point. We hope this resolves your query. Keep reading and engaging with TrueData for more interesting content!
nicely explained.
Glad you like our work Sir!
When we talk about trading, which security is the most common one that comes to ...
India is increasingly becoming a dominant options trading market with the highes...
Options trading is one of the most significant trading segments and is gaining i...
