What if I sell a CALL?

The last post talked about buying a CALL.  Also in a previous post I described how the risk/return graph changes when we take an opposite position. 

Lets use the same GE March $5 Call (symbol GEWCE).  If you buy the Call (Long the Call) your risk/reward at expiration looks like this:

$5 March 2009 GE Call

And if you sell the Call (Short the Call) your risk/reward at expiration looks like this:

$5 March 2009 GE Call - Short

For this example I have assumed that you can sell the option for the same price that you can buy it.  In reality, if you look at these bid/ask prices in the previous post, you can sell the option for $5.10, a 10 cent difference.  Also, because the spread is 10 cents, it MAY be possible to buy or sell this option for $5.15. 

Notice that the graph is just mirrored about the x-axis.

If GE closes below $5 at expiration, you will have a gain of $5.20, if GE closes at $10.20, you will not gain or lose anything.  As GE goes above $10.20, you will start to have a loss, with the maximum loss being unlimited.  And if GE closes between $5.00 and $10.20 at expiration, you will have some gain.

If you sell the Call, also known as WRITING a Call, you have an OBLIGATION to purchase the underlying stock, in this example GE, for $5.00 if the holder of the option exercises the option.  It is the buyer of the Option that has a choice, or option. 

I do NOT recommend writing NAKED options, because the maximum loss is unlimited.  Naked means that you do not have another position that limits the downside risk.  Understand how options work and paper trade them before taking any positions.

To be continued–