Are the Cincinnati Bengals short call investors?
The second part of the call options series, I want to focus more on the sell side or the short call. The previous article was more heavily focused on the buy side. In the previous example, the sell side was the Cincinnati Bengals. Remember, in the previous example, The Bengals have the obligation, and not the right, to deliver $5 million to Joe Burrow if he reaches his contract incentive of reaching 5,000 pass yards.
SELL SIDE
As the sell side of the option a few things are important to note:
The seller is obligated to deliver shares if exercised by the buyer.
The short investor enters into the position as they are provided an initial payment for the call, known as a premium. The premium is paid to the sell side from the buy side. The seller needs a reason to take part in the transaction and the premium provides that.
Upside risk exists as the investor is provided the premium but will be exercised if the underlying rises above the strike price.
Therefore, the short call investor hopes the underlying does not rise above the strike price.
The obligation to deliver lasts until the expiration date, which is predetermined before entering the trade.
CINCINNATI BENGALS
Now, let’s view this through the lens of the Cincinnati Bengals:
They are obligated to deliver $1 million to Joe Burrow if he reaches 5,000 pass yards, per his contract.
The Bengals receive a premium from Joe Burrow. It may not be an explicit dollar value he provides but they now have a franchise QB who will do promotional events, make the team more successful thus providing more dollars, help to sell more tickets, etc.
Upside risk for the Bengals is if Joe Burrow reaches 5,000 pass yards then they are on the hook for $1 million.
Ultimately, the Bengals wouldn’t be mad if Burrow reaches 5,000 yards, as it probably means a successful season, but the ideal situation is a successful season without 5,000 passing yards.
The Bengals are expected to deliver until the end of the regular season. At that point, the incentive expires.
LET’S RELATE
Now, let’s flip our Apple example to if we were on the sell side. Apple was trading for $142 at the time and we entered a position by selling a short call at $150. Expiration is November 18th and we were able to receive a $100 premium from the buyer in order to enter this position. We are the Cincinnati Bengals.
As 5,000 passing yards is the strike price for the Bengals, $150 is the strike price for our short call in Apple.
As the regular season end is the expiration date for the Cincinnati Bengals, our expiration is November 18th.
As Joe Burrow providing camps, promotional events, making the team more successful, etc. is the premium the Bengals receive; the $100 is the premium we receive for being a short call investor in Apple.
We are happy if the stock price goes to $149.99. As long as the price of Apple stays below $150 up until November 18th similar to if Joe Burrow threw for 4,999 passing yards in the regular season. We will walk away with the $100 and not having been obligated to deliver Apple stock at $150 just as the Bengals will walk away with $1 million still in their pockets and increased value through Joe Burrow’s various endeavors he does for them.