Writing options means selling an options contract where a fee or a premium is collected by the Writer in an exchange for the right to buy and or sell shares at a future price and date. Traders would trade an option by making a new option contract that sells someone a right to purchase or sell a stock at a particular price, called the strike price on a particular date which is called the expiration date. In other words, the Writer of the option could be forced to buy or sell a stock at the strike price.
For this high risk, the Writer will receive a premium that the buyer of the option would pay. The premium received when writing an option will depend on various attributes, including the current price of the stock, when the option expires, and several other factors.
An option writer is also referred to as a grantor and is the seller of an option. He is the one who opens a position to collect a premium payment from the buyer. A writer can sell call or put options that are covered or uncovered. An uncovered position is also known as a naked option.
Option buyers are given the right to purchase or sell an underlying security, within a certain time frame, at a particular price by the option seller or Writer. For this, the option has a cost called the premium. The premium is what an option writer needs. The premium amount is what option writers are after. They will get paid upfront but face high risk if the option gets very valuable to the buyer.
An option is uncovered - when the Writer does not have an offsetting position in the account. The Writer will potentially face high loss if the options that they write are uncovered. This means that they do not own shares they write calls on or do not hold short shares in the option they write puts on. Large losses could result from an adverse move in the underlying price.
The basic objective of the NSE option writer is to generate income through the collection of premiums when the contracts are sold on opening a position. The largest gains happen when the contracts that have been sold expire out of the money.
For the call writer, options expire out of the money when the share price falls below the strike price of the contract. Out of the money puts expire when the price of the underlying share closes above the strike price. In both situations, the Writer will keep the whole premium received for the sale of the contracts. When the option moves in the money, the Writer faces a loss as they are required to buy the option back for higher than they had received.
In other terms, covered writing is known to be a more conservative strategy for the generation of income; Uncovered option writing is known to be highly speculative as there is the potential for unlimited losses.
Mentioned below are the major differences between call writing and put writing of options.
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Call Writing |
Put Writing |
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The buyer of a call option needs the right, but he or she does not have to buy an agreed quantity by the specific date for a particular price. |
Buyers of the put option have the right but are not required to sell an agreed quantity by a particular date for the strike price. |
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The premium is paid by the buyer. |
The premium is paid by the buyer. |
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The call writer is required to sell the underlying asset to the option holder if the option is exercised. |
The Writer is required to purchase the underlying asset from the option holder when the option is exercised. |
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It increases as the value of the underlying asset goes high. |
It decreases as the value of the underlying asset increases. |
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The security deposit is allowed to be taken at a certain price if the investor wishes. |
The insurance here is protected against the loss in value. |
Option writers would pay close attention to time value. The longer that an option has until the expiration - then the greater its time value, as there is a greater possibility it could move into the money. The possibility is of value to option buyers - and so they would pay a bigger premium for a similar option with a longer expiry than the shorter expiry.
As an option is close to expiry, the main determinant of its value is the underlying asset's price relative to the strike price. If the options are in the money, the option value will reflect the difference between the two prices.