What Is Writing an Option?
Let me explain what writing an option really means. When you write an option, you're selling an options contract and collecting a fee, known as the premium, in return for giving someone the right to buy or sell shares at a set price and date in the future.
Key Takeaways
As someone diving into options, you should know that writing an option gets you a premium for letting the buyer have the right to buy or sell shares at a specific price and date. These options for stocks come in lots of 100 shares each. The premium you get depends on things like the stock's current price and the option's expiration date. You'll benefit from an immediate premium, keeping it if the option expires worthless, time decay working in your favor, and the flexibility to manage your positions. But remember, you could lose more than just the premium you received.
Understanding Writing an Option
When you write an option, you're creating a new contract that sells the right to buy or sell a stock at a strike price on an expiration date. This means you might have to buy or sell the stock at that price if the buyer exercises it. For taking on that risk, you get a premium from the buyer. That premium varies based on the stock's price, expiration timing, and factors like volatility of the underlying asset.
Benefits of Writing an Option
One key benefit is getting the premium right away when you sell the contract. If the option expires out of the money—say, for a call, the stock closes below the strike, or for a put, above it—you keep the whole premium. Time decay helps because options lose value over time, lowering your risk; you sold high and can buy back low if needed. Plus, you have flexibility to close out by buying back the option anytime in the market, ending your obligation.
Risk of Writing an Option
Even with the premium, writing options carries loss potential. Take David, who thought Apple's stock would stay flat after the iPhone 11 launch and wrote a $200 call expiring Dec. 20. But Apple announced a 5G iPhone early, stock hit $275, and he had to sell at $200, losing $75 per share. Losses can be unlimited on naked options without other positions. With a covered call, where you own the stock, gains in shares can offset call losses.
Practical Example of Writing an Option
Consider Boeing stock at $375, and you own 100 shares like Sarah does. She thinks it'll stay flat or dip while waiting for airline order news. Tom believes the order comes soon, spiking the stock. Sarah writes a $375 November call, earning $17 premium per share, so $1,700 total. Tom buys it, giving him the right to buy her shares at $375 before November. If no news comes and stock hovers at $375, option expires worthless, Sarah keeps $1,700. But if the order hits and stock jumps to $450, Tom exercises, Sarah sells at $375, losing $7,500 on the stock value but offset by the $1,700 premium.
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