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The Deep In-the-Money short call can be used as a substitute for short stock, but there is no real advantage to doing so.

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Strategy: Deep In-the-Money Short Call

Deep In the Money Short Call Option Graph

The Outlook: Bearish.

The Trade: Sell a deep In-the-Money Call with a couple months or more to expiration.

Gains when: Stock falls.

Maximum Gain: Limited by strike price sold.

Loses when: Stock rises.

Maximum Loss : Unlimited.

Breakeven Calculation: Strike price sold x number of shares represented + initial credit.

Advantages compared to short stock: Less margin required.

Disadvantages compared to short stock: Limited life.

Volatility: after entry, an increase in implied volatility is negative.

Time: after entry, the passage of time is positive if the stock falls.

Margin Requirement : The short call is considered "naked", and the minimum margin would be 10% of the strike price of the short call times the number of shares represented, but probably more.

Variations:

Synthetic Equivalent: Short Stock and Short Put at deep OTM strike price. (A Covered Put.)

Comments

  • This "short stock substitute" strategy takes advantage of the fact that Deep ITM Calls have a large Delta. This means the Short Call will lose value almost as fast as the short stock would on a drop in stock price. And since you are short the Call, you want it to lose value.
  • This strategy should only be used if you are very bearish on a stock. If the stock rises, your dollar losses will be just as large as if you were short the stock.
  • This strategy is presented just to show it is possible. In actual trading, there is no real advantage to shorting a Deep ITM Call as opposed to shorting the actual stock. Shorting the actual stock will bring more of a credit into your account.
  • The short strike will limit your gains to that strike price. So if you thought the example stock might drop to 35, then you should sell the 35 strike call.

Exits

  • This strategy can have dollar losses as large as if you actually shorted the stock. For this reason, you should always have a stop loss, just as you would if you shorted stock.

 

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