When the investor is bullish about the stock’s performance and expect stock’s price to go up, he buys (long) a ___________ option.
When the investor is bearish about the stock’s performance, and expect stock’s price to go down, he buys (long) a ____________ option.
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If you cannot answer this question, do go back to my first blog post where I share more on buying call and put options.
http://helmihakim.com/investment/m9a-insurance-regulatory-exam-blog-post-no-1/
It is important that you understand the very basic first, because with very strong fundamentals, you can easily grasp the advanced ones later. Moreover, MCQ exams like M9A test more on your understanding, rather than just pure memory work. If you can answer the above correctly, do continue reading this blog post. 🙂
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There are another group of people who wants to make money. They are the option sellers. They make money by SELLING (writing) a call or a put option. They make money by collecting the option’s premium that the option buyer pays.
Call Option Seller
If these group of people, expect the stock’s price to go down, they sell (write) a call option. They hope, that the price of the stock goes down, and those who buys call option (the investors, i mentioned in my previous blog post) never exercise their right to buy at strike price, since market price is already cheaper. The call option seller makes money, by collecting option premium.
Put Option Seller
Vice versa, if these group of people expect the stock’s price to go up, they sell (write) a put option. They hope, that the price of the stock goes up, and those who buys a put option, never exercise their right to sell at strike price, since the market price is already higher than the strike price. The put option seller makes money, by collecting option premium too! 🙂
Grasp and understand above, before you proceed to the last part of my blog’s post.
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Warning. There are dangers, of being a call or put option’s seller, if you don’t own the stocks.
You have UNLIMITED RISK. If you sell a call or put option without owning the stocks. We call it, that you are selling “naked”.
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Let me give you an example. You sell (write) a call option. The current price of the stock is $30. The strike price is $35.
The call option buyer expects the stock’s price to go up, so that he can buy at strike price and sell it for a profit on the open market. You as the call option seller, hopes the stock’s price to go down, praying that the call option buyer won’t exercise his right to buy at strike price of $35, and you can enjoy the option premium which he pays you.
5 days later, stock’s price jumps to $90. Call option buyer wants to exercise his right to buy the stock at $35. You don’t own the stocks. What, you have to do, is buy the stock from the open market at $90, and sell it back to the call option buyer at strike price of $35. Your risk is unlimited, because the stock price can go up, to $90, $100 or $200. You have no choice but to buy from the open market, and sell it to the call option buyer if you don’t own the stocks.
That is the danger of being an option seller, without owning the stocks in the first place. Your gain is just the option’s premium if option buyer never exercise his right, but your loss is unlimited if option’s buyer exercise his right.
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I hope this sharing is beneficial for you and wait for my next post, which I will share more on option strategies.
Sharing is caring. Share this post around and may all benefit from it! Insya’Allah… 🙂
p.s. By the way, if you wish to discover a simple & halal way to create a positive monthly cashflow and calculate your net worth for FREE, then please click here…
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