Writing An Option

AAA

DEFINITION of 'Writing An Option'

The expression "writing an option" refers to the act of selling an option. An option is the right, but not the obligation, to buy or sell a particular trading instrument at a specified price, on or before its expiration.

When someone writes (or "sells") an option, he or she must deliver to the buyer a specified number of shares if the option is excercised The writer has an obligation to perform a duty while the buyer has the option to take action. There are two general types of option writing: covered and naked.

INVESTOPEDIA EXPLAINS 'Writing An Option'

In a covered call, the option writer already owns the underlying trading instrument and wishes to make extra money from the position. He or she can write (or sell) an option based on the expectation that the underlying's price will move in a particular way. The buyer pays the writer a premium in exchange for writing the option.

If the option trades at a value that benefits the buyer, the seller is obligated to hand over the shares. If the option expires at a value that does not benefit the buyer, the seller retains the original shares. If the option writer does not own the underlying instrument, it is said to be a "naked" option. This is more risky than writing a covered call since the writer is still obligated to produce the specified number of shares of the particular contract (without already owning them).
 

VIDEO

Loading the player...
RELATED TERMS
  1. Delta

    The ratio comparing the change in the price of the underlying ...
  2. Derivative

    A security whose price is dependent upon or derived from one ...
  3. Gamma

    The rate of change for delta with respect to the underlying asset's ...
  4. Theta

    A measure of the rate of decline in the value of an option due ...
  5. Strike Price

    The price at which a specific derivative contract can be exercised. ...
  6. Strike Width

    The difference between the strike price of an option and the ...
RELATED FAQS
  1. When does one sell a put option, and when does one sell a call option?

    The incorporation of options into all types of investment strategies has quickly grown in popularity among individual investors. ... Read Full Answer >>
  2. How can I use an out-of-the-money put time spread for downside risk?

    Long Put Calendar Spread An out-of-the-money put time spread can hedge downside risk by selling an out-of-the-money put ... Read Full Answer >>
  3. Can an investor buy leveraged ETFs that track the automotive sector?

    As of 2015, no leveraged exchange-traded funds, or ETFs, track the automotive sector. However, a non-leveraged ETF tracks ... Read Full Answer >>
  4. What risks should I consider taking a short put position?

    The risks to consider before taking a short put position are the odds of sustained weakness in the asset price and a spike ... Read Full Answer >>
  5. What happens if a software glitch fails to execute the strike price I set?

    If you've ever suffered the frustrating experience of having an order not filled or had a strike price fail to execute because ... Read Full Answer >>
  6. Why should I consider buying an option if it's out-of-the-money?

    One situation when a trader may want to buy an out-of-the-money option is to hedge a stock position. A trader may want to ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Do Option Sellers Have a Trading Edge?

    Take a look at a study that discovered that three out of every four options expired worthless.
  2. Options & Futures

    The Ins And Outs Of Selling Options

    Selling options can seem intimidating but with these tips, you can enter the market with confidence.
  3. Professionals

    The Coming Stock Market Decline: What to Expect

    Many big investors are fearful of a market decline. Even if they're correct there is always a way to profit.
  4. Investing Basics

    What is a Greenshoe Option?

    A greenshoe option is a provision in an underwriting agreement that allows the underwriter to buy up to 15% of the shares in an IPO at the offer price.
  5. Investing Basics

    What Does a Clearing House Do?

    A clearing house is a third-party agency or separate entity that acts as a go-between for buyers and sellers in financial markets.
  6. Options & Futures

    How The New NYSE Binary Options Work

    The New York Stock Exchange has launched its own version of binary options called Binary Return Derivatives Options or ByRDs.
  7. Mutual Funds & ETFs

    4 Ways You Can Invest In Gold Without Holding It

    Owning gold can be a store of value and a hedge against unexpected inflation. Holding physical gold, however, can be cumbersome and costly. Fortunately, there are several ways to own gold without ...
  8. Options & Futures

    How To Profit From Oil Volatility With The Following Strategies

    The recent volatility in oil prices presents an excellent opportunity for traders to make a profit if they are able to predict the right direction.
  9. Active Trading Fundamentals

    How To Short Amazon Stock

    With the stock reaching all-time highs and the company gambling on several new business lines, many investors may feel it's a good time to short sell Amazon.
  10. Trading Strategies

    Profitable Long-Term Consolidation Patterns

    Long-term consolidation patterns set up high reward opportunities for patient market players.

You May Also Like

Hot Definitions
  1. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  2. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  3. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  4. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  5. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
  6. International Monetary Fund - IMF

    An international organization created for the purpose of: 1. Promoting global monetary and exchange stability. 2. Facilitating ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!