Education Series on Derivative Contracts
Limited Profit and Unlimited loss to the Seller:
Unlike a call buyer, the writer of a call option is
bearish on the underlying asset (expects that the price would fall) and
the call is sold on expectation that a profit could be made to the
extent of the premium received. So long as he is right, the seller
makes a profit but this is limited to the premium. On the other side, the call writer may be a big loser if the value of the asset
increases. In such an occasion, he has to buy it from the market at a
higher price to fulfill his obligation to sell to the call buyer and
this loss may be unlimited.
If a call is written on an asset on the backing of long
position(buying) of the same asset in the cash market, it is known as
a covered call. Since, the call seller has bought the required quantity
of the asset in the cash market, losses due to a price increase of the
asset could be eliminated.