Writer

What Is an Option Writer?

A writer (once in a while alluded to as a grantor) is the seller of an option 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 likewise alluded to as a naked option. For instance, the owner of 100 shares of stock can sell a call option on those shares to collect a premium from the buyer of the option; the position is covered in light of the fact that the writer possesses the stock that underlies the option and has agreed to sell those shares at the strike price of the contract. A covered put option would include being short the shares and composing a put on them. On the off chance that an option isn't covered the option writer theoretically faces the risk of exceptionally large losses if the underlying moves against them.

Figuring out the Writer

Option buyers are given the right to buy or sell an underlying security, inside a certain time span, at a predefined price by the option seller or writer. For this right, the option has a cost, called the premium. Option writers are after the premium. They get compensated upfront, yet face high risk (whenever uncovered) on the off chance that the option turns out to be truly significant to the buyer. For instance, a put writer is trusting an underlying stock won't drop below the strike price, the buyer is trusting it will.The further below the put's strike price the underlying falls, the larger the loss for the writer, and the greater the profit for the put buyer.

An option is uncovered when the writer doesn't have an offsetting position in the account. For instance, the writer of a put option, who consents to buy shares at the contract's strike price, is uncovered in the event that there is certainly not a relating short position in their account to offset the risk of buying shares.

The writer faces possibly large losses assuming that the options they compose are uncovered. That means they don't possess shares they compose calls on, or don't hold short shares in the options they compose puts on. The large losses can result from an adverse move in the underlying's price. With a call, for instance, the writer is consenting to sell shares to the buyer at the strike price, say $50. Yet, expect to be that the stock, presently trading at $45, is offered a buyout by one more company for $70 per share. The underlying quickly send off to $65 and wavers there. It doesn't go to $70 on the grounds that there is a chance the deal will not go through. The writer of the option currently needs to buy shares at $65 to sell them at $50 to the option buyer, if the buyer [exercises](/work out) the option. Even on the off chance that the option hasn't expired yet, the option writer is as yet facing a large loss, since they should buy the option back for generally $15 more ($65 - $50) than they composed it for to close out the position.

The primary objective for option writers is to produce income by collecting premiums when contracts are sold to open a position. The largest gains happen when contracts that have been sold terminate out-of-the-money. For call writers, options lapse out-of-the-money when the share price closes below the strike price of the contract. Out-of-the-money puts lapse when the price of the underlying shares closes over the strike price. In the two circumstances, the writer keeps the whole premium received for the sale of the contracts.

At the point when the option moves in-the-money, the compose faces a potential loss since they need to buy the option back for more than they received.

Covered writing is viewed as a conservative strategy for generating income. Uncovered or naked option composing is highly speculative due to the potential for unlimited losses.

Call Writing

Covered call composing generally brings about one of three results. At the point when the options lapse worthless, the writer keeps the whole premium they received for composing the option. Assuming the options will lapse in the money, the writer can either let the underlying shares be called away at the strike price or buy the option to close the position.

Called away means they need to sell their real shares to the option buyer at the strike price, and the buyer will purchase the shares from them. Closing the option position, then again, means buying a similar option to offset the prior sold option. This closes the position and the profit or loss is the difference between the premium received and the price paid to buy the option back.

The results of composing uncovered calls are generally something similar with one key difference. On the off chance that the share price closes in-the-money, the writer must either buy stock on the open market to deliver shares to the option 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

At the point when a put writer is short the underlying stock, the position is covered on the off chance that there is a comparing number of shares sold short in the account. If 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 a similar option to close the position. In the event that the writer buys the shares, the loss is the difference between the strike price and open market price, minus the premium received. In the event that the writer closes the position by buying a put option to offset the sold option, the loss is the premium paid to buy minus the premium received.

Premium Time Value

Option writers pay particularly close regard for time value. The longer an option has until the expiration, the greater its time value, since there is a greater chance it could move into-the-money. This possibility is of value to option buyers, thus they will pay a higher premium for a comparable option with a longer expiry than a shorter expiry.

Time value rots over the long haul, which leans toward the option writer. An out-of-the-money option that trades for $5 has time value on the grounds that the option has no intrinsic value but it actually trades for $5. In the event that an option writer sells this option, they receive the $5. Over the long haul, as long as that option avoids the-money, the value of that option will weaken to $0 at expiration. This permits the writer to keep the premium since they previously received $5 and the option is currently worth $0 and worthless once it lapses out-of-the-money.

As an option gets close to expiry the primary determinant of its value is the underlying's price relative to the strike price. Assuming that the option is in-the-money, the option value will mirror the difference between the two prices. Assuming the option lapses in-the-money, however the difference between the strike price and the underlying's price is just $3, the option seller still really brings in money, since they received $5 and can buy back the position for $3, which is what the option will probably trade at close to expiration.

Instance of Writing a Call Option on a Stock

Accept that Apple Inc. (AAPL) shares are trading at $210. A trader doesn't really accept that that the shares will rise above $220 inside the next two months, so they compose 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 lapses, in two months, when the price of Apple is below $220.

The writer may currently claim shares of Apple, or they could buy 100 shares at $210 to make a covered call. This safeguards them in case the stock shoots higher, say to $230. Assuming the writer sells the option uncovered, and the price rises to $230, then the writer would need to buy shares at $230 to sell to the option buyer at $220, losing the writer $650 (($10 - $3.50) x 100 shares). However, assuming they owned the shares as of now they could just give them to the buyer at $220, make $1,000 on the share purchase ($10 x 100 shares) yet keep the $350 from the option sale.

The downside of the covered call is that assuming the share price drops, they get to keep the $350 option premium however they presently own shares which are falling in value. On the off chance that the shares fall to $190, the writer will keep the $3.50 per share from the option, yet 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, however, which is what they would have lost in the event that they bought the shares yet didn't sell the option.

Highlights

• Option writers like on the off chance that options terminate worthless and out-of-the-money, so they get to keep the whole premium. Option buyers believe the options should lapse in-the-money.
• Option writers collect a premium in exchange for giving the buyer the right to buy or sell the underlying at an agreed price inside an agreed period of time.
• A put or call can be covered or uncovered, with uncovered positions carrying a lot greater risk.