Short call vs. long call

Call options are one of the two major types of options, and investors have two ways to use them: either selling them or buying them. Buying, or going long, calls offers tremendous potential gains, and it tends to be what people think of when they think of options. In contrast, going short calls offers a cash payment upfront but no further gain — and in fact, the potential for significant loss.

Here’s how short calls and long calls work and the key differences between the two.

What is a long call?

A long call is the purchase of a call option. A long call offers the right, but not the obligation, to purchase a stock (or other asset) at a specific price by a specific date, at which point the option expires. The call buyer pays an amount of money called a premium to the seller for this right.

The payoff for going long calls is theoretically infinite. If the stock keeps rising until expiration, the value of the option keeps climbing, too. In fact, the long call climbs faster in percentage terms than the stock price does. This uncapped potential is why going long is attractive to traders.

The drawback of going long calls is that the option has the very real possibility of ultimately being worthless. If the long call is not “in the money” — meaning above the strike price, where it has some value — then it expires worthless and the trader loses the full cost of the long call.

When it’s used: A trader would generally go long calls when the underlying stock is expected to rise, ideally significantly, before expiration.

Example of a long call

Let’s say that stock DEF is trading at $20 per share. You can buy a call on the stock with a $20 strike price for $2, and the option expires in six months. One long call contract costs $200, or $2 * 1 contract * 100 shares.

Here’s the trader’s profit on the long call at expiration.

Above the strike price, the value of the option at expiration rises $100 for every $1 increase in the stock. For example, as the stock goes from $23 to $24 — an increase of 4.3 percent — the profit on the option rises from $100 to $200, a gain of 100 percent. The stock could continue to rise, sending the price of the long call much higher for a relatively small gain in the stock price.

In this example, the trader loses money between a stock price of $20 and $22. The trader paid $2 for the option and so breaks even at a stock price of $22 (the stock price plus the option’s cost). So the option may be in the money at expiration, but the trader may still have lost overall.

Finally, if the stock finishes below $20 at the option’s expiration, it expires worthless and the trader loses the entire investment in the long call.

The best brokers for options trading offer tools that help traders analyze options effectively.

What is a short call?

A short call is the reverse strategy to the long call. Every long call that’s purchased is also sold or “written” by another trader who thinks the option looks attractively priced.

A short call is the sale of a call option. With a short call, the trader promises to sell the stock at a specific price by a specific date to the buyer of that call. For this right, the call seller receives the premium from the trader going long the call and has no more to gain from the transaction.

The payoff for going short calls is limited to the premium paid for the contract. If the stock stays below the call’s strike price, the call seller keeps the whole premium. But the call seller has a potentially huge downside that is exactly the reverse of the call buyer’s upside: If the stock continues to rise, the call seller can lose a theoretically uncapped amount of money.

This potentially unlimited loss is the biggest risk for a call seller, and the short call can lose much more than the premium that was received upfront. However, some options strategies such as the covered call use a short call in a less risky way, by hedging the position with another security.

When it’s used: A trader would generally go short calls when the underlying stock may fall before expiration or at least not rise. If the stock may plummet, traders may instead consider put options.

Example of a short call

Let’s say that stock DEF is trading at $20 per share. You can sell a call on the stock with a $20 strike price for $2, and the option expires in six months. One short call contract yields a premium of $200, or $2 * 1 contract * 100 shares.

Here’s the trader’s profit on the short call at expiration.

The payoff from a short call looks exactly like the inverse of the long call shown before:

• For every stock price below $20, the option expires worthless, and the call writer keeps the full cash premium of $200.
• At stock prices between $20 and $22, the call writer earns a portion of the premium, but the call will be exercised by the buyer and the call writer will not earn the whole $200.
• At stock prices above $22, the call writer loses money overall, losing not only the $200 premium, but also incremental money depending on where the stock closes at expiration.

Traders find the short call attractive because they receive cash upfront and make a promise to deliver the stock to the buyer in the future at a specific price. If the stock doesn’t close above that price when the option expires, they needn’t keep that promise and can pocket the full premium.

The most traders can make is the premium, while the most they can lose is unlimited. That may seem like an unbalanced trade, but calls often expire worthless. Still, if traders go short and the stock skyrockets, they could lose a fortune, as shorts did in GameStop stock in January 2021.

Short calls vs. long calls: What are the key differences?

Short calls and long calls are really inverse strategies, so what’s good for one is bad for the other. Here are the key differences:

• Potential profit: The potential gain on a long call is theoretically unlimited if the stock keeps rising, while the potential profit on a short call is limited to the premium received.
• Potential loss: The potential loss on a long call is the total cost of the premium paid if the option expires worthless. In contrast, the potential loss on a short call is theoretically unlimited if the stock keeps rising until expiration.
• When to use them: Traders use long calls when they expect the underlying stock to rise before expiration. Short calls are for when the stock is expected to fall or at least not rise.
• Rights and responsibilities: A trader with a long call may purchase the option but is not required to do so. In contrast, a trader with a short call will be forced to deliver the stock at the agreed-upon price if the call owner exercises the option to do so.
• Effect of time: The price of an option tends to decline over time, meaning the passage of time works in the favor of the short call and against the long call, all else equal.

FAQs about short calls vs. long calls

• Are short calls or long calls riskier?

  Short calls have a theoretically infinite potential for loss if the stock continues to rise. Before that happens, however, your broker will issue a margin call, but it still could wipe out your account. You could lose much more from a short call than you ever got from the trade.

  In contrast, the net loss on a long call is always limited to the cost of the option. Yes, you can lose the entire investment if the stock finishes expiration below the strike price, but you’ll never lose more than that. While the loss is capped here, options routinely expire worthless.

• Are short calls or long calls good ways to invest?

  Options are much more about short-term trading than they are about long-term investing. With options, you’re making a bet against another trader about how a stock will perform over a certain period of time, not unlike a horse race. Options eventually expire, and then the bets are settled.

  In contrast, a stock could theoretically exist indefinitely, as long as it didn’t go bankrupt or wasn’t acquired. Long-term investors are investing in the ongoing success of the business rather than betting on stock prices with other investors. So investors can make a lot of money over time if they can identify good stocks or invest in a collection of solid stocks such as the S&P 500 index.

• How long does a short call last?

  A call can last from as little as a day with zero-day options to around 2.5 years with options called LEAPs (long-term equity anticipation securities), which are simply long-lived options. Traders can choose the call they want to write from the available choices of expiration, though exactly which options are available in a given month depend on the options cycle for that stock.

• Is it better to do a long call or short call?

  The right option strategy depends on your investment thesis for the stock. If you think the stock is set to rise, it may make sense to go long calls. If you think the stock is ready to fall, it could make sense to go short calls. Picking the wrong strategy is one of the biggest risks of trading options.

  So it’s important to understand what options strategies are available and how they match up with how you expect the stock to perform.

Bottom line

Short calls and long calls both offer ways to make money on the moves of a stock or index, giving traders a way to profit regardless of how the security performs. But it’s vital to understand the pros and cons of each strategy and when it’s appropriate to use them.