Mastering Derivatives: When Short Call Is Preferred To Short Futures

Previously in this column, we discussed an aggressive strategy initiated to take advantage of a potential bull exhaustion. The strategy involved going short on Nifty futures and simultaneously going short on a call option. This week, we continue this discussion, explaining the benefits and the costs of combining a short call with a futures contract. 

Time-decay benefit

Futures contract does not suffer from time decay as options do. That means futures can have a near one-to-one movement with the underlying even closer to contract expiry. With options, the quicker the underlying moves in the preferred direction after you initiate the position, the better. But that argument holds true for long option position. If you are short on options, the slower the underlying moves after you initiate the position, the better it is for the position. 

Suppose you have a view that a bull exhaustion could result in the price declining slowly. So, shorting futures is a better alternative than going long on a put. But why also short a call option? This question is relevant because margins on the short call are similar to that of short futures position. Importantly, futures can offer larger gains for a given movement in the underlying. So, you might as well short an additional futures contract instead of shorting a call. But shorting an option has a benefit. The risk in betting on a bull exhaustion is that the underlying may pause and then continue to gallop upwards. The near one-to-one movement in futures can expose your position to large losses. So, doubling your futures position is risky. If you short a call option, a sharp upside in the underlying may not cause a sharp movement in the call option. This is because time decay works against the option position and reduces the losses you incur should the underlying move up. Regardless, you must trade with tight stop-loss.

Optional Reading

When an underlying moves up, the call option price moves up, captured by its delta. The gamma accelerates the delta but is of a small value. The theta slows the upward movement of an option price when the underlying moves up, as time value reduces with each passing day. When the underlying moves down, the call option price typically declines more than it rises for the same change in the underlying price. This is because the delta and the theta work against the option with only the gamma working in its favour when the underlying declines. The issue is that delta is of a larger value compared to the gamma. The delta captures the change in the option price for a one-point change in the underlying. So, when the underlying declines and delta flips from a positive to a negative factor, the decline in the option price is greater. It is this factor that you are hoping to benefit from when you combine a short call with a short futures position. 

(The author offers training programmes for individuals to manage their personal investments)

Published on May 17, 2025

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