Naked Puts and Covered Calls

[NOMINDTR]

And in any kind of hedging, you have to calculate appropriate lots using beta values. Otherwise you may over or under hedge, which would not be fruitful

 

[Sunil]

a question to anyone who is a regular stock options trader (actually more of a stock options writer):

Say, u r bearish on a particular stock CMP 100. So, u sell one lot of that's stock out-of-money call option at strike price 110.
But, your direction call goes wrong, and that stock turns bullish....
obviously, your 110 Call, which you sold/written, starts making loss....
soon, the CMP of stock reaches 110, and that call option becomes at or in-the money, and u have STILL NOT SQUARED OFF THAT POSITION, THINKING THAT CORRECTION IS IMMINENT..

my question is:
have u faced such a situation where u did not square off such loss-making written stock option, but one fine day, u find that it has been "exercised" by your option buyer (who thinks that 110 is good for him to book his profits,, and exercise his right)...
is there a one-to-one connection between you two parties, in real, practical life....????

(I have purposely mentioned stock options, as in India, stock options can be exercised even before settlement/expiry day (last thursday of month) unlike index options....)

 

[NOMINDTR]

a question to anyone who is a regular stock options trader (actually more of a stock options writer):

I am not. Though I don't get few points.

Say, u r bearish on a particular stock CMP 100. So, u sell one lot of that's stock out-of-money call option at strike price 110.

That's right

the CMP of stock reaches 110, and that call option becomes at or in-the money,

I am afraid it is not in-the-money. It is at-the-money, as the strike and spot are same.

but one fine day, u find that it has been "exercised" by your option buyer (who thinks that 110 is good for him to book his profits,, and exercise his right)...

I don't understand the buyer booking profits. As the option is at-the-money (NOT in-the-money), that is spot and strike are same, only thing he would lose the premium paid. Where is the profit he gets from? Kindly clarify if I am wrong

(I have purposely mentioned stock options, as in India, stock options can be exercised even before settlement/expiry day (last thursday of month) unlike index options....)

That's Cool, an American

 

[NOMINDTR]

gsalvadi,
a person, buying Call 110 when stock price is at 100 (obviously premium must be less at that time)...

When stock price reaches 110, his Call 110 would have generated profit for him, as obviously premium also must have risen proportionately....

Won't a "normal" trader look to book profits then???
It's profit for the call buyer, and loss for that call-writer...

What was confusing about this???

When you speak about exercising an option, there is no point of premium comes into the scene. Premium paid is the setup cost basically. And for your information, premium is not counted (whatever profits in premium one has) to determine whether the option is out the money, in the money or at the money. Only strike price and spot being considered world wide.

And if the buyer sees some profits in premium, he would sell it off. He should not exercise it. Closing at evening could be anything. The closing could eat up his premium profits.

 

[Sunil]

When you speak about exercising an option, there is no point of premium comes into the scene. Premium paid is the setup cost basically. And for your information, premium is not counted (whatever profits in premium one has) to determine whether the option is out the money, in the money or at the money. Only strike price and spot being considered world wide.

And if the buyer sees some profits in premium, he would sell it off. He should not square off. Closing at evening could be anything. The closing could eat up his premium profits.

yup... i realised my mistake in wording my earlier question....,

i realised that i am mentioning "exercising" instead of square off.... i deleted that message, but u were quick to respond to it...

 

[Sunil]

NOW WORDING IT CORRECTLY...

a question to anyone who is a regular stock options trader (actually more of a stock options writer):

Say, u r bearish on a particular stock CMP 100. So, u sell one lot of that's stock out-of-money call option at strike price 110.
But, your direction call goes wrong, and that stock turns bullish....
obviously, your 110 Call, which you sold/written, starts making loss....
soon, the CMP of stock reaches 115, and that call option becomes in-the-money, and u have STILL NOT SQUARED OFF THAT POSITION, THINKING THAT CORRECTION IS IMMINENT..

my question is:
have u faced such a situation where u did not square off such loss-making written stock option, but one fine day, u find that it has been "exercised" by your option buyer (who thinks that 115 is good for him to book his profits,, and exercise his right)...
is there actually a one-to-one connection between the two parties (option buyer & seller), with regard to THAT particular contract, in real, practical life....????
Has this ever happened with you before???

(I have purposely mentioned stock options, as in India, stock options can be exercised even before settlement/expiry day (last thursday of month) unlike index options....)


Don't look into figures in detail....
All I want to know that, has anyone ever faced this situation, when his non-squared off loss-making sold/written option has been exercised, and one fine morning, he finds it missing from his "net position" statement, because it has been exercised by the option buyer...???

 

[AW10]

Hi Sunil, let me try to answer your question. Option writing is part of my strategy. I have had painful lesson with Stock Option that I wrote. Thanks to poor liquidity of Stock options in Indian mkt. I wanted to squareoff but couldn't buy it back as there was no seller. So I can relate to what u are asking.

Say, u r bearish on a particular stock CMP 100. So, u sell one lot of that's stock out-of-money call option at strike price 110.
But, your direction call goes wrong, and that stock turns bullish....
obviously, your 110 Call, which you sold/written, starts making loss....
soon, the CMP of stock reaches 110, and that call option becomes at or in-the money, and u have STILL NOT SQUARED OFF THAT POSITION, THINKING THAT CORRECTION IS IMMINENT..

my question is:
have u faced such a situation where u did not square off such loss-making written stock option, but one fine day, u find that it has been "exercised" by your option buyer (who thinks that 110 is good for him to book his profits,, and exercise his right)...
is there a one-to-one connection between you two parties, in real, practical life....????

Lets say the buyer decides to excercise his right to buy stock at 110(I am not considering whether it makes sense or not..Thats different question ).
He gives instruction thru his broker to exchange for this excercise. The exchange randomly picks a option writer and passes the instruction thru option writers broker for Cash Settlement of this obligation. In this case the obligation amount will be (dayend Settlment price - strike price)*lot size.
In order for this txn to make sense, stock CMP needs to go above strike price.

I will never know who this person is.. Settlment is always thru exchange.. like in any Equity txn we never know the other party, same is true here as well.

As a Option seller, if option gets excercised then it is good for me. As in above case, it helps in cutting my loss.

Hope it gives more clarity.

Happy Trading

 

[ashu1234]

I am not. Though I don't get few points.



That's right



I am afraid it is not in-the-money. It is at-the-money, as the strike and spot are same.



I don't understand the buyer booking profits. As the option is at-the-money (NOT in-the-money), that is spot and strike are same, only thing he would lose the premium paid. Where is the profit he gets from? Kindly clarify if I am wrong



That's Cool, an American

Well Mr gsalvadi, u got caught here in your own words(i must say that your basics are quite through but i somehow find one fault). U said above that buyer would lose the premium but actually at 110 buyer will recover his full premium that he has paid or atleast some part of it(as nobody mentioned the amount of premium so i assume its 10+). So its wrong to say he would lose premium. Yeah he would have booked profit if prices could have gone a bit up.

Correct me if i'm wrong.

Regards
Ashu

 

[Sunil]

Hi Sunil, let me try to answer your question. Option writing is part of my strategy. I have had painful lesson with Stock Option that I wrote. Thanks to poor liquidity of Stock options in Indian mkt. I wanted to squareoff but couldn't buy it back as there was no seller. So I can relate to what u are asking.



Lets say the buyer decides to excercise his right to buy stock at 110(I am not considering whether it makes sense or not..Thats different question ).
He gives instruction thru his broker to exchange for this excercise. The exchange randomly picks a option writer and passes the instruction thru option writers broker for Cash Settlement of this obligation. In this case the obligation amount will be (dayend Settlment price - strike price)*lot size.
In order for this txn to make sense, stock CMP needs to go above strike price.

I will never know who this person is.. Settlment is always thru exchange.. like in any Equity txn we never know the other party, same is true here as well.

As a Option seller, if option gets excercised then it is good for me. As in above case, it helps in cutting my loss.

Hope it gives more clarity.

Happy Trading

yup, this is what i wanted to know....

though as gsalvadi rightly pointed out & even u agree, it makes little sense for such opposite part (option buyer) to exercise.. rather, he would make more money if he closes his position and enjoy the premium difference...

Coming to my original question, even i used to think that exchange would randomly pick an option writer for executing the option buyer's exercise request...

BTW, this was just a hypothetical question - no option writer would actually keep his position open till such an extent of loss....
just wanted to know the WORKING of the "exercise procedure" and the parties involved...

THANKS GSALVADI & AW10 FOR YOUR REPLIES & TIME YOU TOOK OUT FOR ANSWERING MY DOUBT...

 

[Sunil]

Well Mr gsalvadi, u got caught here in your own words(i must say that your basics are quite through but i somehow find one fault). U said above that buyer would lose the premium but actually at 110 buyer will recover his full premium that he has paid or atleast some part of it(as nobody mentioned the amount of premium so i assume its 10+). So its wrong to say he would lose premium. Yeah he would have booked profit if prices could have gone a bit up.

Correct me if i'm wrong.

Regards
Ashu

No Ashu,
Gsalvadi is right....

say, u r the second party in my hypothetical situation...
when CMP is 100, u buy Call 110 (assume @ Rs 5 premium) as u r bullish on the stock...
your analysis turns right and stock price reaches 110... (assuming premium now Rs 15)

Now, two options u have to close this position, but in both case, ur profit will be different:

1. you sell that option, and thus u earn premium difference of Rs 10 (15-5) per lot... thus Rs 10 is your gross profit (before brok, etc)

2. you choose to exercise this option.... as rightly mentioned by gsalvadi, "exercise" is done between close price & strike price.
If the close price of your stock is 110 & strike price is also 110, you would get NIL credit (110-110)
on this NIL credit, you have to reduce your premium initial paid (Rs 5).. thus, you have actually incurred a Gross Loss of Rs 5 (before brok etc)...

overall, it would be better to sell/square-off that option instead of exercising that option, for the option buyer



if suppose you "exercise" when Close is 115, then you would get credit of Rs 5 (115 close price minus 110 strike price)...
On this Rs 5 credit, you have to reduce the initial premium paid (Rs 5)...
here too, you are making NIL gross profit, if your choose to "exercise" your option