InvestorQ : What are the important things I need to know about being an option seller?
Nisha Chandani made post

What are the important things I need to know about being an option seller?

3 years ago

While a buyer of a call estimates that the price of the stock will go above a point, the seller of a call takes a view that the price will not go above that point. Similarly, the buyer of the put believes that price will go below a point while the seller of the put believes that price will not go below that point. An option seller or option writer takes a contrary view rather than a direct view. For example, if the option seller believes that the stock will not go below a certain level then the option writer will sell a put option. Similarly, if the option writer believes that the stock or index will not go above a certain level then he will sell a call option.

The seller of a put option and the seller of a call option have unlimited risk. Let us understand this risk better. If you have sold a Tata Motors 200 call option at Rs.7, then your maximum profit is Rs.7. If the stock price goes up beyond Rs.200 then your loss will be unlimited. For example, if the price goes up to Rs.220, then the Rs.20 is your loss. Of course, this loss stands reduced to Rs.13 because you already earned Rs.7 as option premium. The reverse situation will work in case the option seller has sold a put option. In that case, the risk to the put seller is on the downside movement of the price.

Theoretically, an options seller also runs the risk of assignment of option. This risk arises in case of American options and not in case of European options. In the above case, if the Tata Motors 200 call with premium of Rs.7 has gone up to Rs.215, then it is possible some buyer may choose to exercise this option. When an option is exercised the stock exchange will randomly assign the liability to sellers. If it gets assigned to you then you will have to bear the net loss of Rs.10 on your position. However, with all options now becoming European options, that is not a big risk any longer.