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Short Call Option

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Transcript

Let's take a look at short call options now shorted call options. So long is another word for buy. And short is another word for a sell. Now earlier we did an example where we had someone who's long a call option. And that meant that they had the right to buy a stock at a degraded price today. And now we're going to look at what is the person on the other end of that transaction doing what is the counterparty doing?

So we need to understand that short call options are the counterparties view to a long call option. Now, that may sound a little tricky, so let's work our way through it. Someone who is long call option what happens? They buy, they pay for premium, they have the right they have a long call option. Now, let's say that strike price was $100. And let's say the price rose up to $101 that's what the stock asset went up to.

So they now buy at 100. They can now sell at $101. And we'll say in this case that the profit was zero. So what's going on with the person who gave them that call option who sold them that call option? Well, they in the very beginning, they collect that premium, they collect the dollar until the call option gets exercised, and at that point, they're actually starting to lose money. Because someone else is going to buy something for them from them for less than they can get.

So anywhere in this range, they're actually losing money. So they will have to buy it at $101. They will then be able to sell it At $100, because that's what the strike prices. And so that means that their net profit is zero in this example. So what's going on here is that the person who's short the call option and the person whose long call option, in this case, they actually balance out at this one price. And you can see that neither party actually made any profit they actually made zero profit.

However, if the price is anything other than $101, someone else is making money and someone else is losing money. What happens if the price is below the call the strike price, if the price of the stock is below the strike price, then that means that the person who was short the call option will be collecting the premium. The person who was long call option will be paying that premium but they won't have any incentive to exercise the call option. So that means that they are actually just going to collect the premium and that's it. They just collect whatever that profit is. And if in a real life scenario, you know that the stock is going to go down, that is one alternative, you can either short the stock or you could short a call option and you can collect that money.

Now, what happens if the price is higher than the strike price? Well, in that case, the person who is long the call option is going to be collecting profit and they have unlimited potential upside, the stock price just keeps going up infinitely. They can just only pay this one price and they can collect whatever that new price of the asset is. So they have unlimited potential gain. But the person who is short the call option now has unlimited potential loss It's a zero sum game, someone's gaming someone's losing. So this is how a short call option works.

You just need to realize that it is the counterparty to someone who has long a call option and that whenever someone is collecting someone else's paying the other side

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