What is Call Writing?

Looking for call writing meaning? If you have been trading for a long time, you must have come across terms such as call writing. 

Call writing means an option contract that gives you (the seller) the right to buy and sell shares at a particular price on or before a particular date. This type of option contract is bound by terms and conditions. With call writing, you have the right to buy but are not obligated to purchase shares at a predetermined price. 

Let us understand more about call writing meaning in detail. Keep reading!

Types of Call Writing

In writing a call option, if exercised by the holder, the person will sell the call option to the holder and is obliged to sell the share at the strike price. In return, the seller gets a premium paid by the buyer. 

Let us understand the types of call writing: 

Covered Call Writing

In covered call writing, the investor writes the call options for which he owns the underlying. You can use this strategy if you have a feeling that the stock is about to go down or remain constant in the near term or short term, but want to hold the shares in the portfolio. 

In the above case, you might end up earning a premium as the price falls. On the contrary, if the price increases, you would sell the underlying to the buyer of the call option. In this way, the writer can limit its loss by comparing the strike price at which the underlying is sold and the premium earned by selling or shorting the call option. 

Example of Call Writing

For example, Raju owns 100 shares of XYZ company, currently trading at ₹3,700. Raju believes the stock may stay flat or rise only slightly. He sells 1 call option with a strike price of ₹3,800, expiring in one month, and earns a premium of ₹60 per share (₹6,000 total for the lot of 100 shares).

• Outcome A: XYZ stays below ₹3,800 at expiry

Raj keeps the ₹6,000 premium. He still holds the 100 TCS shares.

This is the best-case scenario for him.

• Outcome B: XYZ rises above ₹3,800 (say ₹3,900)

The call option is exercised. He must sell his 100 shares at ₹3,800. He misses out on the ₹100 gain per share, but still keeps the ₹6,000 premium.

Effective selling price = ₹3,800 + ₹60 = ₹3,860.

This is a covered call, as Raj owns the stock and is okay selling it at ₹3,800.

Naked Call Writing 

In the case of naked call options, a seller of the call option doesn’t own the underlying assets. Investors use this strategy of writing naked call when they are speculative or think the share prices are not going to move up. 

In the case of naked call writing, the seller earns the premium paid by the buyer. However, if the share price goes up, the seller could face unlimited losses. This happens as the seller doesn’t own the stock, and he would have to buy it at a higher market price to sell it to the buyer at the lower strike price or borrow it from a broker.

Example of Naked Call Writing

Raju believes XYZ (currently at ₹2,800) won’t go above ₹3,000 in the near term. He sells a naked call option with a strike price of ₹3,000, earning a premium of ₹30 per share.

• Outcome A: XYZ stays below ₹3,000

He keeps the entire premium of ₹30 per share.

No further obligation, pure profit.

• Outcome B: XYZ rises to ₹3,100

The buyer exercises the option.

He doesn’t own the stock and must buy it at market price (₹3,100) and sell it to the buyer at ₹3,000.

Loss = ₹100 per share – ₹30 premium = ₹70 loss per share.

This is a high-risk strategy, as losses can be unlimited if the stock keeps rising.

Benefits of Call Writing 

Call writing offers a few benefits, such as: 

• Additional Income: With call writing, you will be able to generate additional income by selling call options on assets. Especially in stagnant markets, the premium received from the option buyer adds to the investor’s overall return, providing a consistent revenue stream.

• Risk Management: If you are an investor who is looking for downside protection without having to sell assets. With call writing, you can manage risk by offsetting potential losses in the underlying asset. The premium earned helps in reducing the impact of a price decline. 

• Better Portfolio Returns: With a long-term holding strategy, call writing improves portfolio returns. You can earn income on assets by selling call options on stocks or assets that are otherwise underperforming or not actively contributing to your portfolio growth.

Risks and Considerations

As a call writer, you must keep a few risks and considerations in mind, such as: 

• Limited profit: One of the main drawbacks of call writing is that it limits your potential profits with unlimited risk. If the asset price goes up sharply, you might face losses or miss out on gains beyond the option’s strike price. 
• Possibility of unpredictable losses: In the case of naked call writing, you don’t own the underlying asset. If the asset’s price increases sharply, you must purchase it at a higher market price to fulfill the contract. This creates the possibility of unpredictable losses.
• Required to sell underlying assets: In covered call writing, you (the call writer) must sell the underlying asset if the buyer exercises the option. This could prompt you to part with assets that the buyer intends to hold long term, impacting investment goals or resulting in tax implications. 

Conclusion 

To conclude, call writing should be exercised by the investors who are experienced traders with a proper understanding of the market. Call writing can be a riskier option, especially naked call writing with unlimited losses. You must exercise call writing when you have proper insights on the market, with the ability to take risks and want to make quick profits. If you are a trader, you can trade with our BlinkX App with zero brokerage.