Why does shorting a call option have potential for unlimited loss?
"You are likely making an assumption that the ""Short call"" part of the article you refer to isn't making: that you own the underlying stock in the first place. Rather, selling short a call has two primary cases with considerably different risk profiles. When you short-sell (or ""write"") a call option on a stock, your position can either be: covered, which means you already own the underlying stock and will simply need to deliver it if you are assigned, or else uncovered (or naked), which means you do not own the underlying stock. Writing a covered call can be a relatively conservative trade, while writing a naked call (if your broker were to permit such) can be extremely risky. Consider: With an uncovered position, should you be assigned you will be required to buy the underlying at the prevailing price. This is a very real cost — certainly not an opportunity cost. Look a little further in the article you linked, to the Option strategies section, and you will see the covered call mentioned there. That's the kind of trade you describe in your example."
"No.  The more legs you add onto your trade, the more commissions you will pay entering and exiting the trade and the more opportunity for slippage.  So lets head the other direction.   Can we make a simple, risk-free option trade, with as few legs as possible? The (not really) surprising answer is ""yes"", but there is no free lunch, as you will see.  According to financial theory any riskless position will earn the risk free rate, which right now is almost nothing, nada, 0%.   Let's test this out with a little example. In theory, a riskless position can be constructed from buying a stock, selling a call option, and buying a put option.  This combination should earn the risk free rate. Selling the call option means you get money now but agree to let someone else have the stock at an agreed contract price if the price goes up.  Buying the put option means you pay money now but can sell the stock to someone at a pre-agreed contract price if you want to do so, which would only be when the price declines below the contract price.  To start our risk free trade, buy Google stock, GOOG, at the Oct 3 Close:   495.52 x 100sh = $49,552 The example has 100 shares for compatibility with the options contracts which require 100 share blocks. we will sell a call and buy a put @ contract price of $500 for Jan 19,2013.   Therefore we will receive $50,000 for certain on Jan 19,2013, unless the options clearing system fails, because of say, global financial collapse, or war with Aztec spacecraft. According to google finance, if we had sold a call today at the close we would receive the bid, which is 89.00/share, or $8,900 total.  And if we had bought a put today at the close we would pay the ask, which is 91.90/share, or $9190 total. So, to receive $50,000 for certain on Jan 19,2013 we could pay $49,552 for the GOOG stock, minus $8,900 for the money we received selling the call option, plus a payment of $9190 for the put option we need to protect the value.  The total is $49,842.   If we pay $49,842 today, plus execute the option strategy shown, we would have $50,000 on Jan 19,2013.  This is a profit of $158, the options commissions are going to be around $20-$30, so in total the profit is around $120 after commissions.   On the other hand, ~$50,000 in a bank CD for 12 months at 1.1% will yield $550 in similarly risk-free interest.   Given that it is difficult to actually make these trades simultaneously, in practice, with the prices jumping all around, I would say if you really want a low risk option trade then a bank CD looks like the safer bet.  This isn't to say you can't find another combination of stock and contract price that does better than a bank CD -- but I doubt it will ever be better by very much and still difficult to monitor and align the trades in practice." Depending on the structure of you're portfolio, it could be that your portfolio is delta neutral to take advantage of diminishing time value on options, short straddles/strangles would be an example. The day trader in the article was engaging in short selling.  Short selling is a technique used to profit when a stock goes down.  The investor borrows shares of a stock from someone else and sells them.  After the stock price goes down, the investor buys the shares back and returns them, pocketing the difference. As the day trader in the article found out, it is a dangerous practice, because there is no limit to the amount of money you can lose. The stock was trading at $2, and the day trader thought the stock was going to go down to $1.  He borrowed and sold 8,400 shares at $2.  He hoped to buy them back at $1 and earn $8,400 profit.  Instead, the stock went up a lot, and he was forced to buy back the shares at $18.50 per share, or about $155,400.  He had had $37,000 with E-Trade, which they took, and he is now over $100,000 in debt. "Q: A: Everyone that is short is paying interest to the owners of the shares that the short seller borrowed. Although this quells your conundrum, this is also unrelated to the term. Interest in this context is just the number. In the options market, each contract also has an open interest, which tells you how many of that contract is being held. For your sake, think of it as ""how many are interested"", but really its just a completely different context." When you buy a call option, you transfer the risk to the owner of the asset. They are risking losing out on gains that may accumulate in addition to the strike price and paid premium. For example, if you buy a $25 call option on stock XYZ for $1 per contract, then any additional gain above $26 per share of XYZ is missed out on by the owner of the stock and solely benefits the option holder. "Being ""Long"" something means you own it.  Being ""Short"" something means you have created an obligation that you have sold to someone else.  If I am long 100 shares of MSFT, that means that I possess 100 shares of MSFT.  If I am short 100 shares of MSFT, that means that my broker let me borrow 100 shares of MSFT, and I chose to sell them.  While I am short 100 shares of MSFT, I owe 100 shares of MSFT to my broker whenever he demands them back.  Until he demands them back, I owe interest on the value of those 100 shares.  You short a stock when you feel it is about to drop in price.  The idea there is that if MSFT is at $50 and I short it, I borrow 100 shares from my broker and sell for $5000.  If MSFT falls to $48 the next day, I buy back the 100 shares and give them back to my broker.  I pocket the difference ($50 - $48 = $2/share x 100 shares = $200), minus interest owed.  Call and Put options.  People manage the risk of owning a stock or speculate on the future move of a stock by buying and selling calls and puts.  Call and Put options have 3 important components.  The stock symbol they are actionable against (MSFT in this case), the ""strike price"" - $52 in this case, and an expiration, June.  If you buy a MSFT June $52 Call, you are buying the right to purchase MSFT stock before June options expiration (3rd Saturday of the month).  They are priced per share (let's say this one cost $0.10/share), and sold in 100 share blocks called a ""contract"".  If you buy 1 MSFT June $52 call in this scenario, it would cost you 100 shares x $0.10/share = $10.  If you own this call and the stock spikes to $56 before June, you may exercise your right to purchase this stock (for $52), then immediately sell the stock (at the current price of $56) for a profit of $4 / share ($400 in this case), minus commissions.  This is an overly simplified view of this transaction, as this rarely happens, but I have explained it so you understand the value of the option.  Typically the exercise of the option is not used, but the option is sold to another party for an equivalent value.  You can also sell a Call.  Let's say you own 100 shares of MSFT and you would like to make an extra $0.10 a share because you DON'T think the stock price will be up to $52/share by the end of June.  So you go to your online brokerage and sell one contract, and receive the $0.10 premium per share, being $10.  If the end of June comes and nobody exercises the option you sold, you get to keep the $10 as pure profit (minus commission)!  If they do exercise their option, your broker makes you sell your 100 shares of MSFT to that party for the $52 price.  If the stock shot up to $56, you don't get to gain from that price move, as you have already committed to selling it to somebody at the $52 price.  Again, this exercise scenario is overly simplified, but you should understand the process.  A Put is the opposite of a Call.  If you own 100 shares of MSFT, and you fear a fall in price, you may buy a PUT with a strike price at your threshold of pain.  You might buy a $48 June MSFT Put because you fear the stock falling before June.  If the stock does fall below the $48, you are guaranteed that somebody will buy yours at $48, limiting your loss.  You will have paid a premium for this right (maybe $0.52/share for example).  If the stock never gets down to $48 at the end of June, your option to sell is then worthless, as who would sell their stock at $48 when the market will pay you more?  Owning a Put can be treated like owning insurance on the stock from a loss in stock price.  Alternatively, if you think there is no way possible it will get down to $48 before the end of June, you may SELL a $48 MSFT June Put.  HOWEVER, if the stock does dip down below $48, somebody will exercise their option and force you to buy their stock for $48.  Imagine a scenario that MSFT drops to $30 on some drastically terrible news.  While everybody else may buy the stock at $30, you are obligated to buy shares for $48.  Not good!  When you sold the option, somebody paid you a premium for buying that right from you.  Often times you will always keep this premium.  Sometimes though, you will have to buy a stock at a steep price compared to market.  Now options strategies are combinations of buying and selling calls and puts on the same stock.  Example -- I could buy a $52 MSFT June Call, and sell a $55 MSFT June Call.  I would pay money for the $52 Call that I am long, and receive money for the $55 Call that I am short.  The money I receive from the short $55 Call helps offset the cost of buying the $52 Call.  If the stock were to go up, I would enjoy the profit within in $52-$55 range, essentially, maxing out my profit at $3/share - what the long/short call spread cost me.  There are dozens of strategies of mixing and matching long and short calls and puts depending on what you expect the stock to do, and what you want to profit or protect yourself from.  A derivative is any financial device that is derived from some other factor.  Options are one of the most simple types of derivatives.  The value of the option is derived from the real stock price.  Bingo?  That's a derivative.  Lotto?  That is also a derivative.  Power companies buy weather derivatives to hedge their energy requirements.  There are people selling derivatives based on the number of sunny days in Omaha.  Remember those calls and puts on stock prices?  There are people that sell calls and puts based on the number of sunny days in Omaha.  Sounds kind of ridiculous -- but now imagine that you are a solar power company that gets ""free"" electricity from the sun and they sell that to their customers.  On cloudy days, the solar power company is still on the hook to provide energy to their customers, but they must buy it from a more expensive source.  If they own the ""Sunny Days in Omaha"" derivative, they can make money for every cloudy day over the annual average, thus, hedging their obligation for providing more expensive electricity on cloudy days.  For that derivative to work, somebody in the derivative market puts a price on what he believes the odds are of too many cloudy days happening, and somebody who wants to protect his interests from an over abundance of cloudy days purchases this derivative.  The energy company buying this derivative has a known cost for the cost of the derivative and works this into their business model.  Knowing that they will be compensated for any excessive cloudy days allows them to stabilize their pricing and reduce their risk.  The person selling the derivative profits if the number of sunny days is higher than average.  The people selling these types of derivatives study the weather in order to make their offers appropriately.  This particular example is a fictitious one (I don't believe there is a derivative called ""Sunny days in Omaha""), but the concept is real, and the derivatives are based on anything from sunny days, to BLS unemployment statistics, to the apartment vacancy rate of NYC, to the cost of a gallon of milk in Maine.  For every situation, somebody is looking to protect themselves from something, and somebody else believes they can profit from it.  Now these examples are highly simplified, many derivatives are highly technical, comprised of multiple indicators as a part of its risk profile, and extremely difficult to explain.  These things might sound ridiculous, but if you ran a lemonade stand in Omaha, that sunny days derivative just might be your best friend..." You haven't said why you think you will gain at $41, but the graph never lies. Take it one piece at a time: At $41, your stock will lose a big chunk of value.  Your short calls will expire.  Your puts will gain a bit of value.  The stock's loss outweighs the option gains. The problem with short would be that even if the stock eventually falls, it might raise a lot in the meantime, and unless you have enough collateral, you may not survive till it happens.  To sell shares short, you first need to borrow them (as naked short is currently prohibited in US, as far as I know). Now, to borrow you need some collateral, which is supposed to be worth more that the asset you are borrowing, and usually substantially more, otherwise the risk for the creditor is too high. Suppose you borrowed 10K worth of shares, and gave 15K collateral (numbers are totally imaginary of course). Suppose the shares rose so that total cost is now 14K. At this moment, you will probably be demanded to either raise more collateral or close the position if you can not, thus generating you a 4K loss. Little use it would be to you if next day it fell to 1K - you already lost your money!  As Keynes once said, Markets can remain irrational longer than you can remain solvent. See also another answer which enumerates other issues with short selling. As noted by @MichaelPryor, options may be a safer way to do it. Or a short ETF like PSQ - lists of those are easy to find online. "&gt; It just has to finish below the strike price of the short (which can be higher than the stock's current price).  You're talking about a put option.   That's one ""short"" strategy, but it's not shorting a stock, so the terminology is a little jumbled.   There are reasons to not do straight options, because they can be quite risky, and you have to get the time frame correct." You sold a call, and have a risk if the stock rises.  You bought a put and gain when the stock drops. You, sir, have a synthetic short position.  It's Case 3 from your linked example: Suppose you own Long Stock and the company is going to report earnings   but you’re going on vacation. How can you hedge your position without   selling your stock? You can short the stock synthetically with   options! Short Stock = Short Call + Long Put They conclude with the net zero remark, because the premise was an existing long position. A long plus this synthetic short results in a neutral set of positions (and the author's ability to go on vacation not concerned about any movement in the stock.) You would generally have to pay interest for everyday you hold the position overnight.  If you never close the position and the stock price goes to zero, you will be closed out and credited with your profit. If you never close the position and the stock price keeps going up and up, your potential loss is an unlimited amount of money.  Of course your broker may close you out early for a number of reasons, particularly if your loss goes above the amount of capital you have in your trading account. Sounds like an illiquid option, if there are actually some bidders, market makers, then sell the option at market price (market sell order). If there are not market makers then place a really low limit sell order so that you can sit at the ask in the order book. A lot of time there is off-book liquidity, so there may be a party looking for buy liquidity. You can also exercise the option to book the loss (immediately selling the shares when they get delivered to you), if this is an American style option. But if the option is worthless then it is probably significantly underwater, and you'd end up losing a lot more as you'd buy the stock at the strike price but only be able to sell at its current market value. The loss could also be increased further if there are even MORE liquidity issues in the stock. The uptick rule is gone, but it was weakly reintroduced in 2010, applied to all publicly traded equities: Under the terms of the rule, a circuit breaker would be triggered if a stock falls by 10% or more in a single day. At that point, short selling would only be allowed if the price is above the current national best bid, a restriction that would apply for the rest of the day and the whole of the following day. Derivatives are not yet restricted in such ways because of their spontaneous nature, requiring a short to increase supply; however, this latest rule widens options spreads during collapses because the exemption for hedging is now gone, and what's more a tool used by options market makers, shorting the underlying to offset positive delta, now has to go to the back of the selling line during a panic. Bonds are not restricted because for one there isn't much interest in shorting because bonds usually don't have enough variance to exceed the cost of borrowing, and many do not trade frequently enough because even the cost to trade bonds is expensive, so arranging a short in its entirety will be expensive.  The preferred method to short a bond is with swaps, swaptions, etc. In India the only way to short a stock is using F&O which I personally find to be sufficient for any shorting needs. However, Futures can be generally sold for upto 3 months but options have more choices which are even upto 5 years you can buy a put of a longer duration and when you want to do buy-back, you can directly sell the same option by squaring-off the trade before expiry date. You generally get approximately the same profit as shorting but you get to limit your risk. Adding to the answers above, there is another source of risk: if one of the companies you are short receives a bid to be purchased by another company, the price will most probably rocket...