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Definition: Short Call
Short call is a strategy practiced by many investors. This strategy basically involves selling what you don’t have. In case of short call, the investors are benefitted if the value of the stock falls below the price at which they exercised this option. This price is known as strike price. In short call what actually happens is that, suppose market expects stock X to fall below its current price levels, then in that case in order to book profits, investors sell the shares of company X in the market. These shares are not actually held by the investors, but they take it from their brokers for the purpose of selling it in the market.
Now, if the price of the of the security or the stock falls below the strike price then, they buy from the market and the difference between the strike price and the price at which they buy is the net profit booked by the investors. But usage of this strategy exposes the investors to the huge risk of making losses, if the market price of the security moves against the market expectations. This short call is also called as naked call or uncovered call.
For example: you are sure that price of a security is going to fall in the coming week. The current market price of that security is Rs. 25. So, you sell that security today at this price. This security you did not actually had, but you borrowed it from your broker. Now, if the market moves as per your expectation and let’s assumes that the price of the security becomes Rs. 20. Now, after one week broker will ask you for his security, so you will buy this security at Rs 20 and the difference of Rs 5 excluding all the taxes and transaction charges will be your booked profit.
Diagrammatically, short call can be explained as above.