InvestorQ : Why do people so often lose money in selling options?
sarah Leo made post

Why do people so often lose money in selling options?

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2 years ago

In fact, some of the biggest disasters in the options market have happened when options were sold. Back in 2004-05, Reliance Industries was stuck in a narrow range due to the corporate battle. An investor in Bengaluru was making a killing each month writing call options on the stock and taking away the premium. Then in 2005 the split happened and the stock shot through the roof. The man lost all his profits and a lot more. This is what can happen when you sell options.

How exactly does option selling work in terms of pay offs. For starters, when you sell a call option, you bet that the upsides are limited; and you sell a put, when you believe that downsides are limited. What you earn is the premium and what you will eventually pay is the price movement that goes against you. But in between, please remember, there is also a fund allocation in terms of initial margin and MTM margins to be done.

When you sell options, your income is premium but your liability can be unlimited. When you buy options your risk is limited to the premium paid. You at least know your maximum loss. But assume you sold 2 lots (1000 shares) of Tata Motors 520 call at Rs.12. You receive Rs.12,000, which is your maximum profit. But if the price of Tata Motors goes up to Rs.600, you lose Rs.68,000/- net. Now that is a rip-off for you, right? Be very cautious. In the past, some of the biggest disasters in the F&O space like the Barings debacle had happened due to selling options without any risk management.