Buy-Write

What Is a Buy-Write?

A buy-write is an options trading strategy where an investor buys a security, generally a stock, with options accessible on it and at the same time writes (sells) a call option on that security. The purpose is to create income from option premiums. Since the option position possibly diminishes in value assuming the price of the underlying security increases, the downside risk of composing the option is limited.

The most common illustration of this type of strategy is composing a covered call on a stock previously owned by an investor.

How the Buy-Write Strategy Works

This strategy expects the market price for the underlying security will probably change just gently and perhaps rise to some degree from current levels before expiration. On the off chance that the security declines in price or possibly doesn't rise a great deal, then the investor composing the call option will keep the premium received from the options sale. This strategy can be periodically rehashed to increase returns during when the movement of the security is dreary.

To execute this strategy well, the strike price of the option ought to be higher than the price paid for the underlying. This requires great judgment in light of the fact that the strike price should be higher than the probable degree of change, however not so high that the premium received is unimportant.

Likewise, the longer the time until expiration, the higher the premium will be. Notwithstanding, the longer the term before expiration, the greater the chance that the security can rise too far. For the strategy to find success, investors must find a balance between expiration time and expectations of volatility.

Different Considerations

Should the underlying asset price rise over the strike price then the option will be exercised at maturity (or before), bringing about the investor selling the asset at the strike price. This situation actually brings about profits, however as a rule adds up to less profit than if the option strategy had not been utilized.

In this way, even however the investor actually keeps the premium received from the option, they never again benefit from any extra gain in the underlying price. As such, in exchange for the premium income, the investor covers their gain on the underlying.

Ideally, the investor trusts that the underlying won't rally in the short term however will be a lot higher in the long term. The investor procures income on the asset while waiting for the eventual long-term rise in price.

Illustration of a Buy-Write Trade

Assume an investor accepts that XYZ stock is a decent long-term investment however is uncertain of when its product or service will turn out to be genuinely profitable. They choose to buy a 100-share position in the stock at its market price of $10 per share. Since the investor doesn't anticipate that the price should rally soon, they likewise choose to write a call option for XYZ stock at a exercise price of $12.50, selling it for a small premium.

However long the price of XYZ stays below $12.50 until maturity, the trader will keep the premium and the underlying stock. In the event that the price rises over the $12.50 level and is exercised, the trader will be required to sell the shares at $12.50 to the option holder. The trader will just miss out on the difference between the exercise price and the market price.

On the off chance that the market price at expiration is $13.00 per share, the investor misses out on the extra profit of $13.00 - $12.50 = $0.50 per share. Note that this is money not received, as opposed to money lost. On the off chance that the investor just writes a uncovered or naked call, they would need to go out of the dark market to buy the shares to deliver, and the $0.50 per share would turn into a real capital loss.

Highlights

• A covered call is a common illustration of a buy-write strategy.
• A buy-write is a somewhat okay options position that includes claiming the underlying security while composing options on it.
• Buy-writes require choosing the right strike price and expiration date to expand gains.