Establishing a Basic Understanding of Selling Call Options

1. Understanding the Concept of Selling Call Options

For those unfamiliar with options, selling options might seem confusing. Common questions include: "How can I sell an option if I don’t own any?" or "What’s the point of selling an option?" To help clarify this concept, let's use a real-life example of selling a used car.

Used Car Sale Analogy

Imagine you own a used car currently valued at 20,000 yuan. You believe its price won’t significantly increase in the next few months. So, you decide to sell a call option on the car.

• Buyer (Friend B): Your friend B wants to buy your car but doesn’t have enough money right now. He wants the option to buy it at 20,000 yuan within the next three months.

• Seller (You): You agree to grant Friend B this right by selling a call option. In return, you collect 1,000 yuan as an option premium.

Possible Scenarios:

1. Car Price Stays the Same or Decreases:
   If the market price remains 20,000 yuan or lower after three months, Friend B won’t exercise his option. He can buy the same car at the same or a lower price elsewhere.
   ✅ You keep the car and the 1,000 yuan premium.

2. Car Price Increases to 25,000 Yuan:
   If the price rises to 25,000 yuan, Friend B will exercise his right to buy the car for 20,000 yuan. You must sell it at this price, even though it's now worth more.
   ✅ You receive a total of 21,000 yuan (20,000 from the sale + 1,000 from the option premium).
   ❌ However, you miss out on an extra 5,000 yuan of potential profit.

Applying This to Stocks

In financial markets, prices are determined by fair market value, so you don’t need to own a stock to sell a call option. As long as you have enough funds to buy the stock later, you can fulfill your obligations if the option is exercised.

Selling a call option means you collect an upfront premium in exchange for agreeing to sell an asset at a fixed price in the future. While you immediately receive the premium, a large price increase could limit your potential profits.

2. Duan Yongping’s Call Option Selling Strategy

One hour before Jensen Huang's keynote speech, famous investor Duan Yongping shared his Buy Write trade on NVIDIA (NVDA) via the Chinese investment platform Xueqiu.

Duan’s NVIDIA Buy Write Trade:

• Bought 100,000 shares of NVIDIA at $116.76 per share

• Sold 1,000 call options (covering the 100,000 shares) with a strike price of $120, expiring on March 20, 2026

• Received $2,427 per contract in premium

• Total premium received: $2,427,000

Duan described the trade as:
"Bought NVDA at $92.5, but delivery is delayed by one year."

Trade Breakdown:

1. Structure:

• Stock Purchase:

  • 100,000 shares @ $116.76 = $11,676,000

• Call Option Sale:

  • 1,000 contracts, each with a $120 strike price

  • Premium received: $2,427 per contract

  • Total premium income: $2,427,000

2. Profit and Loss Analysis

✅ Effective Purchase Price:
Since he collected premiums, his adjusted stock cost basis is:

116.76−2,427100=92.49

This is why he mentioned, "I bought NVDA at $92.5, just with delayed delivery."

3. Different Scenarios:

• Stock Price Falls Below $92.49:
  ❌ Duan incurs a paper loss if NVIDIA drops below this level.
  ✅ However, his loss is smaller than if he had only purchased the stock without selling options.

• Stock Price Between $92.49 and $120:
  ✅ His stock gains value but the call option is not exercised.
  ✅ He benefits from price appreciation + option premium.

• Stock Price Above $120 (Option Exercised):
  ❌ The buyer will exercise the option and buy shares at $120.
  ✅ Duan's total profit is capped at:

  (120−92.49)×100,000=2,751,000

  Even if NVDA skyrockets to $200, he cannot profit beyond this amount.

4. Pros and Cons:

✅ Pros:

• Lowers purchase cost: He effectively paid $92.49 instead of $116.76.

• Generates stable income: Even if NVDA doesn’t rise, he earns $2.4M in premiums.

• Best for range-bound or moderate bull markets.

❌ Cons:

• Profit cap: No extra gains if NVDA soars beyond $120.

• Downside risk: If NVDA crashes, he still holds 100,000 shares with a cost basis of $92.49.

3. When to Sell Call Options?

Selling call options is useful in the following scenarios:

1. Neutral or Bearish Market:

   • If you believe the stock won’t rise significantly or may drop, selling call options can generate income.

2. Enhancing Stock Holdings:

   • If you already own the stock, selling covered calls provides extra income from premiums.

3. Hedging:

   • Investors with short positions can sell call options to offset potential losses.

4. Income Generation:

   • Some investors sell call options purely to collect premiums, even if they don’t hold the underlying stock.

Risks to Consider:

Selling naked calls (without owning the stock) carries unlimited risk if the stock soars past the strike price. This strategy is best for experienced investors with strict risk management.

4. Common Questions About Selling Call Options

1. How to Close a Sold Call Option?

• If you sold one contract, your position is -1.

• To close, you simply buy back one contract (-1 + 1 = 0).

2. How Does Profit Change Over Time?

• Profit is affected by time decay and stock price movement.

• The closer to expiry, the more the option loses value, benefiting the seller.

3. How to Calculate the Breakeven Point?

Breakeven=Strike Price+Premium Received

4. Difference Between Holding Until Expiry vs. Closing Early?

• At expiry, the option’s time value is zero.

• Closing early forfeits some time value but reduces exposure.

5. What Happens When a Sold Call Option Expires?

• If the stock price is below the strike price, the option expires worthless, and you keep the premium.

• If the stock price exceeds the strike price, you must sell the stock at the agreed price.

Conclusion

Selling call options allows investors to generate income, hedge positions, and reduce cost bases. However, it also caps upside potential and involves risks if the stock price surges. This strategy is best suited for investors who expect moderate price movements and want stable returns.