What Is Overwriting?
Let me explain overwriting to you directly: it's a trading strategy where you sell options that you believe are overpriced, assuming they won't get exercised before they expire.
Key Takeaways
You should know that overwriting means selling options that are overpriced, with the hope they won't be exercised. I use it to generate extra income, particularly with options on dividend-paying stocks. Remember, overwriting is risky and you should only try it if you have a solid understanding of options and related strategies.
How Overwriting Works
Overwriting is a speculative strategy that some option writers like me might use to collect a premium, even if we think the underlying security is misvalued, hoping we don't get assigned on those short options. You might hear it called 'overriding' too.
As the writer of an option, you're obligated to deliver shares if the buyer exercises, while the buyer has the right but not the obligation to buy at a set price within a time frame. Overwriting lets speculative writers profit from premiums paid by buyers for contracts we hope expire unexercised. It's risky, so only attempt it if you're well-versed in options.
If you hold a dividend-paying stock, overwriting can boost your income by collecting the premium from writing an option against it. For instance, if your stock gives a 3% dividend yield, you could push that effective yield above 10% through overwriting. This works best after sharp stock price declines when premiums are inflated, helping offset further losses.
The risk is that if the stock price surges, you lose out on profits above the strike price. To handle this, you might buy back the option, but expect to pay more than you received.
Overwriting Example
Suppose you hold a stock trading at $50. You write a $60 call option expiring in three months and get a $5 premium. If the stock goes above $60 before expiry, the buyer will likely exercise, capping your profit at $15 per share (the $10 difference plus $5 premium) on a potentially rising asset. That's why you hope it expires worthless—you keep the premium and hold the rising stock. If the stock drops, the $5 premium offsets some of your loss.
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