Most speculators understand that you can buy calls for bullish speculating and that you can do covered call writing for income. But on some occasions, calls can be a form of hedging. When would you use call options for protection?
If you're doing short selling because you think that a particular stock or asset is a good bearish candidate, consider buying a call option against your short position as a form of insurance.
For example, if you're shorting 200 shares of MMC Corporation at $50 per share, then consider buying two calls on MMC at $50 or $51 if possible. Why two calls? An option contract covers 100 shares, so two contracts would give you more coverage.
Going short is a form of speculating. The danger is that the stock you're shorting will reverse and rally upward, meaning that you'll incur losses. Because a call option gains value when the underlying stock is increasing, it works as a good hedge or form of insurance against unlimited losses.
Because shorting a stock is typically a short-term pursuit, you don't need to buy long-term (also called long-dated) call options. If you see yourself shorting a stock for two or three months, then consider getting an option for four months, giving you some cushion on the time. Buying the short-term call option can be an inexpensive way to limit your potential loss.
