Question

You sell one August 155 Call contract for $5.. Determine the breakeven point, the maximum profit and loss. In which market do you use this strategy? Is it more a hedging strategy or speculation?

Answer 1

Sell Call strategy- This is a bearish strategy. When you think that market or particular stock will go down, you can sell a call, if stock price does not come down, still you can get profit due to time decay, based on time value of money, options lose their value as the time passes and expiry comes nearer. A trader can use ITM, ATM or OTM call option in this strategy but a deep Out of the money call option gives profit in this strategy.

Profit- Limited to the premium received

Loss- Unlimited as the upside is unlimited.

Break even point- Strike price + Premium received on selling call option.

In this question:

Maximum profit = $5 (premium)

Maximum loss = Unlimited (As the underlying increases, loss will increase)

Break even point: 155 + 5 = $160

This is more a hedging strategy, if you have stocks in holding and you think that price can drop, you can sell call of the same stock.