Loading the player...
A:

The incorporation of options into all types of investment strategies has quickly grown in popularity among individual investors. For beginner traders, one of the main questions that arises is why traders would wish to sell options rather than to buy them. The selling of options confuses many investors because the obligations, risks and payoffs involved are different from those of the standard long option.

To understand why an investor would choose to sell an option, you must first understand what type of option it is that he or she is selling, and what kind of payoff he or she is expecting to make when the price of the underlying moves in the desired direction.

Selling a put option - An investor would choose to sell a put option if her outlook on the underlying security was that it was going to rise. The purchaser of a put option pays a premium to the writer (seller) for the right to sell the shares at an agreed upon price in the event that the price heads lower. Since the premium would be kept by the seller if the price closed above the agreed upon strike price, it is easy to see why an investor would choose to use this type of strategy. (To learn more, see Introduction To Put Writing.)

Selling a call option without owning the underlying asset - An investor would choose to sell a call option if his outlook on a specific asset was that it was going to fall. The purchaser of a call option pays a premium to the writer for the right to buy the underlying at an agreed upon price in the event that the price of the asset is above the strike price. In this case, the option seller would get to keep the premium if the price closed below the strike price. (For more on this strategy, see Naked Call Writing.)

Another reason why investors may sell options is to incorporate them into other types of option strategies. For example, if an investor wishes to sell out of his or her position in a stock when the price rises above a certain level, he or she can incorporate what is known as a covered call strategy. (To learn more, see Come One, Come All - Covered Calls.) Many advanced options strategies - iron condor, bull call spread, bull put spread, iron butterfly - will likely require an investor to sell options.

To learn more about options, see our Options Basics Tutorial.

RELATED FAQS
  1. Do options make more sense during bull or bear markets?

    Understand how options may be used in both bullish and bearish markets, and learn the basics of options pricing and certain ... Read Answer >>
  2. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  3. Can I make money using put options when prices are going up?

    It seems counterintuitive that you would be able to profit from an increase in the price of an underlying asset by using ... Read Answer >>
  4. Are put options more difficult to trade than call options?

    Learn about the difficulty of trading both call and put options. Explore how put options earn profits with underlying assets ... Read Answer >>
  5. How do speculators profit from options?

    As a quick summary, options are financial derivatives that give their holders the right to buy or sell a specific asset by ... Read Answer >>
  6. What is index option trading and how does it work?

    Learn about stock index options, including differences between single stock options and index options, and understand different ... Read Answer >>
Related Articles
  1. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
  2. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  3. Trading

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  4. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
  5. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  6. Trading

    Options Pricing

    Options are valued in a variety of different ways. Learn about how options are priced with this tutorial.
  7. Trading

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
RELATED TERMS
  1. Bear Call Spread

    A type of options strategy used when a decline in the price of ...
  2. In The Money

    1. For a call option, when the option's strike price is below ...
  3. Exotic Option

    An option that differs from common American or European options ...
  4. Compound Option

    An option for which the underlying is another option. Therefore, ...
  5. Option

    A financial derivative that represents a contract sold by one ...
  6. Option Premium

    1. The income received by an investor who sells or "writes" an ...
Hot Definitions
  1. Restricted Stock Unit

    Compensation offered by an employer to an employee in the form of company stock. The employee does not receive the stock ...
  2. Operating Ratio

    A ratio that shows the efficiency of a company's management by comparing operating expense to net sales. Calculated as:
  3. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  4. Pro Forma

    A Latin term meaning "for the sake of form". In the investing world, it describes a method of calculating financial results ...
  5. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  6. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
Trading Center