3 Easy Ways to Go Short with Call Options

Selling options is a great way to generate additional income every month. You sell the call option and receive the sales price. Then you let it expire and you get to keep the premium that you received.
But with the obvious benefits of that extra income, there is a definite downside. Selling a Call option means that you agree to sell someone 100 shares of stock at a certain price.

Let's look at a quick example. If Apple Computer (AAPL) is currently selling for $95, and you sell a call option for $100, then you have committed to sell someone 100 shares of AAPL for $100. Not a big deal, but what if the market price of AAPL goes up to $120? If you have to buy the shares at $120 and then sell them for $100, you've just taken quite a loss. Here are 3 ways to protect yourself from incurring a loss when selling calls.

First, the covered call. Along with selling the call, you buy the 100 shares of stock. Then if the market price rises, you already own the stock and can easily sell it at the strike price. If you buy the stock at $95 and sell the strike 100 Call option, even if the stock rises to $120, you can sell your stock for $100. You won't make as much as you would have if you had only had the stock, but you will still make a profit on that trade.

Another way to protect the short call from becoming a severe liability is to simultaneously buy a call at a higher price. This is often referred to as a bear call spread. Suppose you sell the AAPL strike 100 call. If you also buy the strike 110 call, then even if the market price of AAPL goes to 120, you will only lose $10 per share. No matter how high the market price rises, you can buy the stock at 110 and sell it for 100, only losing $10 per share. The strike 110 call protects you from significant loss. And if the stock stays below 100, you will get the maximum profit from your short call.

The third way to protect your short call is with a long call in the following month. This is referred to as a call calendar. Buying the long call in the next month will be more expensive, but it has a key advantage in that it will not decay with time as quickly as the short call in the near month. If the price of the stock stays stagnant, the long call will not lose much value at all, and your short call will decay to zero. Then you sell the long call back and you've done well for the month.

Selling a call option gives you extra money each month. If you can protect yourself from large movements in the price of the stock, you can happily take that short call premium to the bank every