Short Calls

Writing a call can be risky depending on whether your position is covered or uncovered. Either way, call writers typically believe the stock's price will either fall or stay neutral, leaving the option out-of-the-money and worthless.

You take less risk by writing a call on stocks you already own, which is also known as writing a covered call. Instead of being forced to purchase shares in the secondary market if the option is exercised, you can relinquish shares you own. Since you'll receive a premium when you sell the call, plus the exercise price, you may have a net profit and will at least reduce the net loss if you paid more for the shares than you sold them for at exercise. Covered calls offer very limited protection in a bear market.

Uncovered, or naked, calls are much riskier. If you write an uncovered call, you'll need to purchase the shares in the secondary market at market price before surrendering them to the option holder at exercise. Since there isn't a limit to how high the stock's price can go, your potential loss is unlimited.

Short Call Graph

In the graph shown here, the vertical (Y-axis) represents profit and loss, while the horizontal (X-axis) shows the price of the underlying stock. The blue line shows your potential profit or loss given the price of the underlying.

On Margin

Although you generally can't purchase options on margin as you can stocks, you'll need that ability if you want to write uncovered calls. Since uncovered calls expose you to more risk than other options strategies, your brokerage firm wants to make sure you'll have enough capital to meet your obligation should the option be exercised. You'll have to maintain the margin requirement, which is typically 20% of the underlying stock's worth minus the amount the option is out-of-the-money, though this amount cannot be less than 10% of the underlying security's value. If the assets in your account fall below the margin requirement, you'll receive a margin call and be required to add additional capital to meet the minimum.

Each brokerage firm has the right to set additional requirements above the exchange minimums.

Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation at 1-888-OPTIONS or by visiting www.888options.com). All option accounts require prior approval by Scottrade. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.