Composing an Option

What Is Writing an Option?

Composing an option alludes to selling an options contract in which a fee, or premium, is collected by the writer in exchange for the right to buy or sell shares at a future price and date.

Figuring out Writing an Option

Traders compose an option by making another option contract that sells somebody the right to buy or sell a stock at a specific price (strike price) on a specific date (expiration date). At the end of the day, the writer of the option can be forced to buy or sell a stock at the strike price.

In any case, for that risk, the option writer receives a premium that the buyer of the option pays. The premium received while composing an option relies on several factors, including the current price of the stock, when the option terminates, and different factors, for example, the underlying resource's volatility.

Benefits of Writing an Option

A portion of the primary benefits of composing an option include:

Premium received immediately: Options writers receive a premium when they sell an option contract.

Save full premium for expired out of the money options: If the written option lapses out of the money — implying that the stock price closes below the strike price for a call option, or over the strike price for a put option — the writer keeps the whole premium.

Time decay: Options decline in value due to time decay, which decreases the option writer's risk and liability. Since the writer sold the option at a higher cost and has previously received a premium, they can buy it back for a lower price.

Flexibility: An options writer has the flexibility to close out their open contracts whenever. The writer eliminates their obligation by just buying back their written option in the open market.

Risk of Writing an Option

Despite the fact that an option writer receives a fee, or premium for selling their option contract, there's the possibility to cause a loss. For instance, suppose David thinks Apple Inc. (AAPL) shares will remain flat for the rest of the year due to a dull send off of the tech company's iPhone 11, so he chooses to compose a call option with a strike price of $200 that terminates on Dec. 20.

Unexpectedly, Apple declares that it plans on delivering a 5G capacity iPhone sooner than expected, and its stock price closes at $275 on the day the option lapses. David actually needs to deliver the stock to the option buyer for $200. That means he will lose $75 per share as he needs to buy the stock on the open market for $275 to deliver to his options buyer for $200.

Note that the losses on composing an option are possibly unlimited assuming the option is written "naked"; that is, in the event that there could be no other related positions. In the event that, in any case, someone composes a covered call (where they are as of now long the stock), the losses in the call that are sold will be offset by expansions in the value of the shares owned.

Useful Example of Writing an Option

We should expect The Boeing Company (BA) stock is trading at $375 and Sarah possesses 100 shares. She accepts the stock will trade flat to marginally bring down throughout the next several months as investors hang tight for news about a potential new order from a major airline.

Tom, then again, accepts the airline will as a matter of fact make the purchase a lot sooner than expected, making the stock spike in the close to term.

Due to these conclusions, Sarah chooses to compose a $375 November call option (equivalent to 100 shares) earning a premium of $17.00. Simultaneously, Tom submits a request to buy a $375 November call for $17.00. Thusly, Sarah and Tom's orders execute which results in a $1,700 credit into Sarah's bank account, and gives Tom the right to buy her 100 shares of Boeing at $375 whenever before the November expiry date.

Assume no news is delivered about when the conceivable order might happen thus the stock keeps on drifting around $375 for a long time. Thus, the option terminates worthless, meaning Sarah keeps the $1,700 premium paid by Tom.

On the other hand, expect the airline declares their purchase in the next couple of days and Boeing's stock leaps to $450. In this case, Tom practices his option to buy 100 shares of Boeing from Sarah at $375. In spite of the fact that Sarah received a $1,700 premium for composing the call option, she likewise lost $7,500 on the grounds that she needed to sell her stock that is worth $450 for $375.

Features

• Composing an option can include losing more than the premium received.
• Put and call options for stocks are typically written in parts, with each parcel addressing 100 shares.
• Traders who compose an option receive a fee, or premium, in exchange for giving the option buyer the right to buy or sell shares at a specific price and date.
• The fee, or premium, received while composing an option relies on several factors, like the current price of the stock and when the option lapses.
• Benefits of composing an option incorporate getting an immediate premium, keeping the premium assuming that the option terminates worthless, time decay, and flexibility.