Writing An Option

Loading the player...

What does 'Writing An Option' mean

Writing an option refers to the opening an option position with the sale of a contract or contracts to an option buyer. When writing a call option, the seller agrees to deliver the specified amount of underlying shares to a buyer at the strike price in the contract, while the seller of a put option agrees to buy the underlying shares. A covered call is written when the underlying shares are held in the seller’s account, while puts are considered to be covered if the seller has sufficient cash in the account to purchase the required amount of shares.

BREAKING DOWN 'Writing An Option'

Put and call options generally cover 100 shares, have a strike price at which shares may be transacted and have an expiration date. Investors can write option contracts to generate portfolio income and, under certain circumstances, be used as an alternative to placing limit orders to buy and sell stocks. When options are written, the money paid for the contract is referred to as a premium.

In the agreement between parties, call option buyers have the right but not the obligation to buy the underlying shares at the strike price prior to the expiration of the contract. With put contracts, buyers have the right but are not obligated to sell shares at the strike price. Option sellers, on the other hand, are required to execute transactions as per contract specifications.

Covered Call Writing

Investors with equity portfolios can use covered call writing to generate income while also setting prices to sell underlying shares. For example, an investor holding 100 shares of a stock trading at $50 can write a one-month covered call with a strike price of $55, receive a premium and sell at $55 if the share price is above the strike price at expiration. If the price stays below the $55 strike price and the option expires, the investor can repeat the process and collect additional premiums monthly until the shares are called away. While this strategy is similar to placing limit orders, there is one key difference. Using a limit order at $55, shares are sold if the price exceeds $55. With covered calls, shares are sold if the price closes above $55 at expiration, unless the call buyer elects to call shares away prior to that date.

Put Writing

Investors can also write covered put options to generate income. In this strategy, the put writer collects a premium for accepting the obligation to buy underlying shares at the strike price. The position is considered to be covered as long as the portfolio has the cash to cover the purchase. If the shares close below the strike price at expiration, the put writer buys the shares at the strike price.

Naked Option Writing

While covered call writing is a relatively conservative strategy, naked writing is highly speculative. Because these strategies are executed without underlying shares on or cash on hand to buy shares, option writers may be subjected to losses far greater than premiums received.

RELATED TERMS
  1. Writer

    The seller of an option who collects the premium payment from ...
  2. Option

    A financial derivative that represents a contract sold by one ...
  3. Call Option

    An agreement that gives an investor the right (but not the obligation) ...
  4. Bear Call Spread

    A type of options strategy used when a decline in the price of ...
  5. Stock Option

    A privilege, sold by one party to another, that gives the buyer ...
  6. Strike Price

    The price at which a specific derivative contract can be exercised. ...
Related Articles
  1. Investing

    Income Strategies for Your Portfolio to Make Money Regularly

    Discover the option-writing strategies that can deliver consistent income, including the use of put options instead of limit orders, and maximizing premiums.
  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

    Write Covered Calls To Increase Your IRA Income

    Covered calls may require more attention than bonds or mutual funds, but the payoffs can be worth the trouble.
  4. Investing

    Getting Acquainted With Options Trading

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

    The Basics Of Covered Calls

    Learn how this simple options contract can work for you, even when your stock isn't.
  6. Trading

    Options Pricing: A Review Of Basic Terms

    The following is intended as a review of basic option terminology, which can be used as a reference as needed: American Options - An option that can be at any point during the life of the contract. ...
  7. Trading

    Three Ways to Profit Using Call Options

    A brief overview of how to provide from using call options in your portfolio.
  8. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
  9. Trading

    Cut Down Option Risk With Covered Calls

    A good place to start with options is writing these contracts against shares you already own.
  10. Trading

    When Should I Sell A Put Option Vs A Call Option?

    Beginning traders often ask not when they should buy options, but rather, when they should sell them.
RELATED FAQS
  1. What is the difference between "right" and "obligation" on a call option?

    Learn what a call option is, what determines a buyer and seller of an option, and what the difference between a right and ... 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. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
  4. When is a call option considered to be "in the money"?

    Learn about call options, their intrinsic values and why a call option is in the money when the underlying stock price is ... Read Answer >>
  5. How does the term 'in the money' describe the moneyness of an option?

    Find out what in the money means about the moneyness of call or put options and what it indicates about the relationship ... Read Answer >>
  6. Are there any risks involved in trading put options through a traditional broker?

    Explore put option trading and different put option strategies. Learn the difference between traditional, online and direct ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center