What Is an Option Writer?

A writer (sometimes referred to as a grantor) is the seller of an option who opens a position to collect a premium payment from the buyer. Writers can sell call or put options that are covered or uncovered. An uncovered position is also referred to as a 澳洲幸运5官方开奖结果体彩网:naked option. For example, the owner of 100 shares of stock can sell a 澳洲幸运5官方开奖结果体彩网:call option on those shares to collect a premium from the buyer of the option; the position is covered because the writer owns the stock that underlies the option and has agreed to sell those shares at the 澳洲幸运5官方开奖结果体彩网:strike price of the contract. A covered put option w🧜ould involve being short the shares and writing a put on them. If an option is not covered the option writer theoretically faces the risk of very large losses if the underlying moves against them.

Understanding the Writer

Option buyers are given the right to buy or sell an underlying security, within a certain time frame, at a specified price by the option seller or writer. For this right, the option has a cost, called the premium. The premium is what option writers are after. They get paid upfront, but face high risk (if uncovered) if the option becomes very valuable to the buyer. For example, a put writer is hoping an underlying stock won't drop below the strike price, the buyer is hoping it will.The further below the put's strike price the underlying falls, the larger the loss for the writer, and the bigger the profit for the put buyer.

An option is uncovered when the writer does not have an offsetting position in the account. For example, the writer of a 澳洲幸运5官方开奖结果体彩网:put option, who agrees to buy shares at the contract’s strike price, is uncovered if there is not a corresponding 澳洲幸运5官方开奖结果体彩网:short position in the♋ir account to offset the risk of buying shares.

The writer faces potentially large losses if the options they write are uncovered. That means they don't own shares they write calls on, or don't hold short shares in the options they write puts on. The large losses can result from an adverse move in the underlying's price. With a call, for example, the writer is agreeing to sell shares to the buyer at the strike price, say $50. But assume that the stock, currently trading at $45, is offered a buyout by another company for $70 per share. The underlying instantly launch to $65 and oscillates there. It doesn't go to $70 because there is a chance the deal won't go through. The writer of the option now needs to buy shares at $65 to sell them at $50 to the option buyer, if the buyer 澳洲幸运5官方开奖结果体彩网:exercises the option. Even if the option hasn't expired yet, the option writer is still facing a large loss, since they will need to buy the option back for roughly $15 more ($65 - $50) than they wrote it for t🌄o c🉐lose out the position.

The primary objective for option writers is to generate income by collecting premiums when contracts are sold to open a position. The largest gains occur when contracts that have been sold expire 澳洲幸运5官方开奖结果体彩网:out-of-the-money. For call writers, options expire out-of-the-money when the 澳洲幸运5官方开奖结果体彩网:share price closes below the strike price🔴 of the contract. Out-of-the-money puts expire when the price of the underlying shares 𝔍closes above the strike price. In both situations, the writer keeps the entire premium received for the sale of the contracts.

When the option moves 澳洲幸运5官方开奖结果体彩网:in-the-money, the write faces a potential loss because theꦐy need to buy the option back for more than they received.

澳洲幸运5官方开奖结果体彩网:Covered writing is considered to be a conservative ♌strategy for generating income. Uncovered or naked option writing is highly speculative because of the potential for unlimited losses.

Call Writing

Some traders will use a covered call strategy. This is especially true with dividend-paying stocks. Dividend shares will se🦹e price action or fluctuations—ꩲoften equal to the expected dividend payment—as the ex-dividend date approaches.

澳洲幸运5官方开奖结果体彩网:Covered call writing generally results in one of three outcomes. When the options expire worthless, the writer keeps the entire premium they received for writing the option. If the options are going to expire in the money, the writer can either let the underlying shares be 澳洲幸运5官方开奖结果体彩网:called away at the strike pri💎ce or buy the option to clo🌞se the position.

Called away means they need to sell their actual shares to the option buyer at the strike price, and the buyer will purchase the shares from them. Closing the option position, on the other hand, means buying the same option to offset the prior 💛sold option. This closes the position, and the profi🌞t or loss is the difference between the premium received and the price paid to buy the option back.

The outcomes of writing uncovered calls are generally the same, with one key difference. If the share price closes in-the-money, the writer must either buy stock on the 澳洲幸运5官方开奖结果体彩网:open market to deliver shares to the o🙈ption buyer or close the position♔. The loss is the difference between the strike price and the open market price of the underlying (negative number), plus the premium initially received.

Put Writing

When 澳洲幸运5官方开奖结果体彩网:a put writer is short the 💧underlying stock, the position is covered if there is a corresponding number of shares sold short in the account. In the event that the short option closes in-the-money, the short position offsets the loss of the written put.

In an uncovered position, the writer must either buy shares at the strike price or buy the same option to close the position. If the writer buys the shares, the loss is the difference between the strike price and open market price, minus the premium received. If the writer ꦇcloses the position by buying a put opti🐷on to offset the sold option, the loss is the premium paid to buy minus the premium received.

Premium Time Value

Option writers pay especially close attention to 澳洲幸运5官方开奖结果体彩网:time value. The longer an option has until the expiration, the greater its time value, because there is a greater chanc🥀e it could move into-the-money. This possibility is of value to option buyers, and so they will♔ pay a higher premium for a similar option with a longer expiry than a shorter expiry.

Time value decays as time passes, which favors the option writer. An out-of-the-money option that trades for $5 has time value because the option has no澳洲幸运5官方开奖结果体彩网: intrinsic value and yet it still trades for $5. If an option writer sells this option, they rece💝ive the $5. As time passes, as long as that option stays out-of-the-money, the value of that option will deteriorate to $0 at expiration. This allows the writer to keep the premium because they already received $5 and the option is now worth $0 and worthless once it expires out-of-the-money.

As an option gets near to expiry the main determinant of its value is the underlying's price relative to the strike price. If the option is in-the-money, the option value will reflect the difference between the two prices. If the option does expire in-the-money, but the difference between the strike price and the underlying's price is only $3, the option seller still actually makes money, because they received $5 and can buy back the position for $3, which is what the option will likely trade at near expiration.

Example of Writing a Call Option on a Stock

Assume that Apple Inc. (AAPL) sha🍨res are trading at $210. A trader doesn't believe that the shares will rise above $220 within the next two months, so they write a $220 strike price call option for $3.50. This means they receive $350 ($3.50 x 100 shares). They will get to ▨keep that $350 as long as the option expires, in two months, when the price of Apple is below $220.

The writer may already own shares of Apple, or they could buy 100 shares at $210 to c🎉reate a covered call. This protects them in case the stock shoots higher, say to $230. If the writer sells the option uncovered, and the price rises to $230, then the writer would have to buy shares at $230 to sell to the option buyer at $220, losing the writer $650 (($10 - $3.50) x 100 shares). But if they owned the shares already they could just give them to the buyer at $220, mak𒊎e $1,000 on the share purchase ($10 x 100 shares) and still keep the $350 from the option sale.

The downside of the covered call is that if the share price drops, they get to keep the $350 option premium but they now own shares which are falling in value. If the shares fall to $190, the writer gets to keep the $3.50 per share from the option, but loses $20 per share ($2,000) on the shares they purchased at $210. Losing $16.50 ($20 - $3.50) per share is better than losing the full $20, though, which is what they would have lost if they bought the shares but didn't sell the option.