What is a short call spread?
A short call spread is a type of options trade where you sell a call option with a higher strike price than the one you buy. This trade collects a credit when it's entered. When the strike prices are closer to the underlying stock’s price, you get more credit, but there is a higher chance that the option will finish in-the-money.
The risk for this strategy is limited to the difference in price between the two strikes, minus the amount you received for entering into the trade. The breakeven point is the short strike price plus the net credit you received.
When to use a short call spread strategy
This trade is usually initiated when the trader believes the price of the underlying asset will be below the strike price of the sold call option on or before expiration. As the expiration date gets closer, the value of the option will go down. This will help make the trade profitable. The closer the short strike price is to the underlying price, the more profitable the trade will be.
How to manage a short call spread position
For this strategy, the net effect of time decay leans positive. The good thing is that time decay will erode the value of the option you sold. The bad thing is that it will also erode the value of the option you bought.
The effect of implied volatility on your position depends on how close the stock price is to your strike prices. If you think the stock price will go down, you want the implied volatility to go down too. That's because it will make the options you’ve sold worth less, and you want them to expire without any value.
If you are wrong about the direction of the stock price and it is getting close to or above the higher strike, then you want implied volatility to go up. This will make the near-the-money option increase in value more quickly than the option that is already in the money. Then the difference between these two options will become less valuable overall.
Short call spread maximum profit potential
The potential profit from a short call spread is limited to the value of the net credit you receive when you open the position.
Short call spread maximum loss potential
The potential loss you could incur is limited to the difference between the lower and higher strike prices, minus the credit you received when you initiated the position.