Option Basics - Need clarification

#1
Hi Guys

I've been educating myself on the merits of option trading over the last few days and have to say i'm finding this particularly enjoyable, far more interesting than just plain jane stock trading. I however have a few basic questions that i need help on -

1) So far i've been trading in NIFTY call and put options...but have only BOUGHT these options and then based on changes in premium prices, sold off to book profits. I have not done the opposite, which is to SELL options without having bought them first. By selling options first, do i effectively become the writer of that option?

2) Should i sell an option, and then wait for price changes, and then buy back the same quantity of that option - is this something that would still make me liable for any losses at the end of the option period? or do i effectively square off the sale of the option by buying back from the market?

3) Selling Covered Calls - I understand the basic concept of first owning the underlying stock and then selling (writing) a call option for a premium. But i would need your help in understanding this with an example as below -
Stock A is trading at Rs. 500 and I own a 100 units of it. I sell a call option of 600 (strike price) till the end of the month for a premium of Rs 50. Now here are the options -
A) If at end of the month (EOM) the stock price is 600 or less, lets say it stays at 500, the option is not exercised, and i basically end up gaining Rs 50 per unit as premium.
B) If the price crosses 600 to lets say 750. What exactly happens then?? both in terms of process and in terms of my liability????
Could someone please explain this to me??

I appreciate any thoughts on the above....
ks
 

Vector

Active Member
#2
Yes short selling options makes u a writer.

Yes to the 2nd. you can aquare off by buying back the option.

If your option ends up in the money u will have to pay the difference. In this case (750-600) x lot size. :)

Happy trading.
 
Last edited:

rkkarnani

Well-Known Member
#3
Yes short selling options makes u a writer.

Yes to the 2nd. you can aquare off by buying back the option.

If your option ends up in the money u will have to pay the difference. In this case (750-500) x lot size. :)Happy trading.
Seems a typo, should be 750-600(Strike price)X Lot size. Your loss will be reduced by the amount you received while selling 50XLot size.

As you were holding just 100 shares of the underlying , your stock has also appreciated to 750. If the lot size is say of 500 shares than we cannot call it a "Selling covered Call" as the call was not fully covered.
But suppose you had the 500 shares in hand and when CMP was 500, you thought the stock is fully priced at say rs.600.00 and you sell a 600 call at rs.50/- Just see how you actually gained :
(Suppose you would have sold the shares when the price touched Rs.600.00)
Now by selling a Call you gained Rs. 50.00 per share more.
Received : Rs.50X500 (lot size) 25000.00 (Selling 600 call at Rs.50.00)
Paid on close : Rs. 150.00 X 500 = 75000 (Difference of Spot price and Strike price)
Extra amount Received on sale of Shares at Rs.750.00 = 150X500=125000/- (Sold shares for 750 instead of 600,i.e. gained 750-650=150 per share)

In Net terms you gained the Primium you received when selling the covered call.

Now look at it if the price of the share never crossed 600/-, you stood to gain the same amount of Rs.50/- per share.

People abroad do it a lot as there is lot of liquidity in Stock options there and they call it as getting "Dividend" from companies without the cos declaring it!!! :D
 

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