InvestorQ : Why does my broker ask me to be extra careful while writing or selling options?
swati Bakhda made post

Why does my broker ask me to be extra careful while writing or selling options?

Answer
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Dia Deshpande answered.
2 years ago


Writing of options is the same as selling an option. Every option has a seller and a buyer. For example when X buys a 320 call option on SBI at Rs.5 his view is that the price of SBI will go above Rs.325 so that he can make a profit after covering the cost of the option. On the downside his maximum loss is restricted to Rs.5. The seller (writer) of the option has a maximum income of Rs.5 but his losses can be unlimited. The option seller will have a view that SBI does not go above 320 so that the entire premium can become his income. That is how option buyers and option writers come together and create the market.

But do you know the risks of writing options? Writing options in Indian market, as in other markets, entails unlimited risk if the price movement is against you. This applies irrespective of whether you are writing options on stock or on indices. The two big disadvantages of options are the risk of negative price movement and the risk of margins. But most importantly, when you write options, the volatility works against you. Remember, volatility favours the buyer of the option but goes against the seller of the option. That means, even if the price is static and the volatility goes up you can still end up in losses. That is why writing of options has to be done with lot of care and caution.