You can certainly lose money with any option, put or call, American or European. In fact, most people who purchase a call or put are going to lose money.
One of the biggest risks of selling a call option is the unlimited potential for loss when you don't own shares of the underlying stock (a “naked call”). This is because if the option is exercised, you must purchase the underlying shares, regardless of how high the price has risen.
The Bottom Line
For a call option to by OTM, it will have a strike price that is above the current market level. An OTM put with have a strike price that is below the current market price. At expiration, if an option is out of the money, it will expire worthless.
Selling call options in the money allows traders to collect higher premiums upfront, and be more profitable when they are right. However, the stock price going up against your expectations is the primary risk to be aware of. Losses can occur if the price surges so you could consider buying a protective leg to cap them.
Since an out of the money option doesn't have intrinsic value, its premium is mainly composed of time value. OTM options don't offer an immediate profit if exercised due to their current unfavorable strike price relative to the underlying asset's market price.
If your long option is ITM at expiration but your account doesn't have enough money to support the resulting long or short stock position, your broker may, at its discretion, issue a do not exercise (DNE) on your behalf, and any gain you may have realized by exercising the option will be wiped out.
What will happen if an option holder does not exercise their right to sell before its expiration? If the option's strike price has not been reached by its expiration date, your brokerage will automatically close the deal and remove the option from your list of open positions.
There is generally no exercise or assignment activity on options that expire out-of-the-money. Owners usually let them expire with no value. Although this is not always the case as post-market underlying moves may lead to out-of-the-money options being exercised and in-the-money options not being exercised.
The entire investment is lost for the option holder if the stock doesn't rise above the strike price. However, a call buyer's loss is capped at the initial investment. In this example, the call buyer never loses more than $500 no matter how low the stock falls.
It's often wrong to exercise an option rather than sell it unless you want to own a position in the underlying stock. Be sure to close it through an offsetting sale if the contract is in the money heading into the expiration and you don't want it exercised.
Sellers of covered call options are obligated to deliver shares to the purchaser if they decide to exercise the option. The maximum loss on a covered call strategy is limited to the price paid for the asset, minus the option premium received.
A naked or uncovered call is when you sell a call option without owning the underlying security or some equivalent. The seller (writer) of the call gets immediate premium income from the option's buyer and will collect the full amount if the option expires out of the money.
The option seller is forced to buy the stock at a certain price. However, the lowest the stock can drop to is zero, so there is a floor to the losses. In the case of call options, there is no limit to how high a stock can climb, meaning that potential losses are limitless.
When you sell an option, the most you can profit is the price of the premium collected, but often there is unlimited downside potential. When you purchase an option, your upside can be unlimited, and the most you can lose is the cost of the options premium.
The Poor Man's Covered Call is an option strategy in which a deep in-the-money call option with a long maturity is first purchased. Subsequently, a Call option sold with a shorter maturity (usually above the current share price).
So, how long should you hold an option trade? Well, it depends on your strategy and your risk tolerance. But if you're looking for a more conservative approach, you might want to consider holding your options for at least 100 days for long positions and 50 days for short positions.
Out-Of-The-Money (OTM)
If this happens, the trader would lose all value paid for the option up front and realize max loss. Prior to expiration, the trader can exit the position by selling it for the market value. If it's worth more than what they paid for it, they would realize a profit.
If you exercise the call when shares trade at $120, then you buy 100 ABC shares for $110 and voilà: your return is $10 per share for a total gain of $1,000. But all that fun isn't free. A call buyer must pay the seller a premium: for example, a price of $3 per share.
Options contracts are valid for a certain amount of time. So if the owner doesn't exercise their right to buy or sell within that period, the contract expires worthless, and the owner loses the right to buy or sell the underlying security at the strike price.
Option value is zero so the premium paid is the loss incurred. Option value is zero so the premium paid is the loss incurred.
It would make little sense to exercise the call when better prices for the stock are available in the open market. So if the option is out of the money, the option holder would be better off selling it before it expires.
To illustrate this, consider two real-life scenarios: If you own a call option that's deep in the money and the stock pays a significant dividend, exercising to capture the dividend might be a smart move. But if the option is out of the money or still holds time value, selling could be a more profitable choice.
If an option expires in-the-money, it will be automatically converted to long or short shares of stock in the associated underlying. Long calls are converted to 100 long shares of stock at the strike price.
WHEN TO CLOSE A LONG CALL OPTION. Buyers of long calls can sell them at any time before expiration for a profit or loss, but ideally the trade is closed for a profit when the value of the call exceeds the entry price for purchasing it.