Series 7: 5.1.2 Short Call

Taken from our Series 7 Top-off Online Guide

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5.1.2  Short Call

Every option has both a buyer and a seller. The seller of the option is called the option writer. She believes LeanTree stock will not rise and is willing to bet on it. She writes the following call option:

Short LNTR Jul 25 call @ 3

In writing the call option, she receives the $3 premium that you as the option buyer have paid. The writer or option seller, whether of a put or a call, will always receive a premium from the buyer. This is her profit if the price of the underlying security goes down or stays the same. If the price of LeanTree drops or stays the same, as she expects, she gets to keep the $300 ($3 x 100 shares). If the price of the underlying stock increases unexpectedly, her breakeven point, like yours, is $28. At $28 per share, she takes a $3 per share loss, which exactly offsets the $3 premium she received.

Graph illustrating the above short call example. The y-axis shows profit and x-axis, centered at the $0 profit point of the y-axis, extends to the left measuring price. A dotted line extends from the +$3 profit, turns down at the sales price of $25, and crosses the x-axis at $28, making $28 the breakeven point.

And if the price of LeanTree rises to $32 and you as the owner of the option contract decide to exercise the call option? She gets a phone call and must deliver 100 shares. If she doesn’t already own the shares, she will have to buy the 100 shares

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