Call Writing - Meaning, Types, Objective, Benefits

Call writing is a type of trading strategy in the options market. It involves selling a call option, which is a contract that gives the buyer the right, but not the obligation, to buy an underlying asset at a specific price before a certain date. The seller of the call option, also called the “writer,” receives a premium in return for taking on the obligation. In simple terms, call writing can be a way to make money from an asset you already own, or even if you do not own it. The goal is to make a profit from the premium collected from selling the option, with the expectation that the price of the underlying asset will not go higher than the strike price.

Open Demat account -  Start investing with a quick setup

What is Call Writing?

Call writing is a strategy used in the stock market where an investor sells a call option, which means they are agreeing to sell the underlying asset (like stocks) to someone else at a certain price, known as the strike price. If the price of the stock does not go above the strike price, the seller of the call option keeps the premium they received when they sold the option. Call writing is often used by investors who think that the price of the asset will stay the same or decrease in the near future. If the price does go up beyond the strike price, the investor may be required to sell the asset at that price, but they keep the premium they earned.

Call Writing Meaning

In call writing, you sell a call option on an asset. You get paid a premium for agreeing to sell that asset at a set price if the buyer wants to buy it. The main goal of call writing is to earn this premium without having to sell the asset, hoping that the price of the asset stays the same or goes lower. If the price goes higher than the strike price, you may have to sell the asset at the agreed-upon price, but you still keep the premium. In simple terms, call writing can be like renting out something you own for a fee. If the renter does not use the item, you keep the fee. If the renter uses it, you give them the item but keep the fee.

Types of Call Writing in Stock Market

There are different types of call writing strategies depending on the risk and reward you want to achieve:

1. Covered Call Writing: This is when you own the stock and sell a call option on it. The main advantage of covered call writing is that you can earn extra income (from the premium) while holding the stock. However, if the stock price goes above the strike price, you may have to sell the stock, potentially losing out on further gains.
2. Naked Call Writing: This is when you sell a call option without owning the underlying stock. This strategy carries higher risk because if the stock price rises significantly, you will need to buy the stock at a higher price to deliver it to the buyer. The potential loss is unlimited in naked call writing, so it is considered riskier than covered call writing.
3. Cash-Secured Call Writing: This is when you sell a call option but hold enough cash or liquid assets to buy the stock if the option is exercised. This reduces the risk compared to naked call writing, but it still requires careful management.
4. Long Call Writing: This is when you sell a call option on a stock you expect to go down or stay flat. If the stock price stays below the strike price, you keep the premium. However, if the stock price rises, your losses can be significant.

The Objective of Call Writing

The main goal of call writing is to make money from the premium received when selling the option. Call writing is best for investors who think the price of the stock will not go above the strike price. In this case, they can keep the premium without having to sell the stock. If the price goes up, the writer may have to sell the stock at the strike price, but they still keep the premium they received. Call writing can be a good strategy for generating income from stocks you already own or for stocks you believe won’t rise much in the short term.

Factors Influencing Call Writing Options

Several factors can influence how successful your call writing strategy will be:

1. Volatility: If the stock is highly volatile, there is a greater chance it will rise above the strike price, which increases the risk of call writing.
2. Time to Expiry: The more time remaining until the option expires, the greater the chance the stock price can move. As the expiration date nears, the value of the option decreases, making call writing more profitable if the stock stays below the strike price.
3. Strike Price: The closer the strike price is to the current market price of the stock, the higher the chance the option will be exercised. Choosing the right strike price is important for minimizing risk.
4. Market Sentiment: If the market is bullish, the stock price may rise, increasing the likelihood of the option being exercised. In contrast, a bearish market may make call writing more profitable.

Call Writing Strategy

The strategy behind call writing is to earn income through the premiums you receive when selling call options. The best time to use this strategy is when you believe the price of the stock will stay stable or decline. You can use covered call writing if you already own the stock and want to generate extra income. It’s a way to enhance your returns by selling options on stocks you plan to hold. However, if you are using naked call writing, you need to be aware of the risks and ensure that you have the financial resources to handle any losses if the stock price goes beyond the strike price.

Benefits of Call Writing

1. Income Generation: Call writing allows you to earn income from stocks you already own by collecting premiums from selling options.
2. Limited Risk: In covered call writing, the risk is limited to the price of the stock minus the premium received.
3. Profit in Sideways Market: Call writing works best in a sideways market where prices are not moving up or down dramatically.
4. Flexibility: You can use this strategy with both stocks you own and stocks you do not own (naked call writing), offering more flexibility in your trading strategy.

Disadvantages of Call Writing

1. Limited Profit Potential: The potential profit from call writing is limited to the premium received, even if the stock price rises significantly.
2. Risk in Naked Calls: If you sell a naked call, you can face unlimited losses if the stock price rises sharply.
3. Potential to Lose Stock: In covered call writing, you may have to sell your stock if the price rises above the strike price.
4. Requires Knowledge: Successful call writing requires a good understanding of the market and the ability to choose the right strike price and expiration date.

Call writing is a popular strategy for generating income, but it comes with both risks and rewards. It is best suited for investors who believe the price of the stock will not rise above the strike price. The strategy can be used in different ways, depending on whether you own the stock or not. By understanding the types of call writing and the factors that influence the market, investors can use call writing to enhance their returns and manage risk.