What does 'Buy-Write' mean?

Buy-write is an options trading strategy where an investor buys an asset, usually a stock, and simultaneously writes (sells) a call option on that asset. The purpose is to generate income from option premiums. Because the options position is covered by the underlying position, the downside risk of writing the option is minimized.

It is very similar to writing a covered call on an existing position in the underlying asset. The only difference is the timing of the two trades.

BREAKING DOWN 'Buy-Write'

This strategy assumes the market price for the underlying will not rise significantly from current levels before expiration. If it does not, then the investor writing the call option gets to keep the premium received from the options sale.

The strike price of the option should be higher than the price paid for the underlying, but the higher the strike the further out of the money it will be, and the lower the premium received will be.

Also, the longer the time until expiration, the higher the premium will be. However, the farther the expiration, the more likely the market will lose liquidity, resulting in less efficient pricing. Therefore, investors must find the balance between strike price and expiration.

Should the underlying asset price rise above the strike price then the option will be exercised at maturity (or before) resulting in the investor selling the asset at the strike price. He/she still keeps the premium received but does not benefit from the additional gain in the underlying price. In other words, in exchange for the premium income, the investor caps his/her gain on the underlying.

Ideally, the investor believes that the underlying will not rally in the short-term but will be much higher in the long-term. He/she earns income on the asset while waiting for the eventual long-term rise in price.

Implementing a Buy-Write Trade

Suppose an investor believes that XYZ stock is a good long-term investment but is unsure of when its product or service will become truly profitable. He/she decides to buy a 100-share position in the stock at its market price of $10 per share. Because the investor does not expect the price to rally soon, he/she also decides to write a call option for XYZ stock at an exercise price of $12.50, selling it for a small premium.

As long as the price of XYZ stays below $12.50 until maturity, the trader will keep the premium and the underlying stock.

If the price rises above the $12.50 level and is exercised, the trader will be required to sell the shares at $12.50 to the option holder. The trade will only lose out on the difference between the exercise price and the market price.

If the market price at expiration is $13.00 per share, the investor loses out on the additional profit of $13.00 - $12.50 = $0.50 per share. Note that this is money not received, rather than money lost. If the investor simply writes an uncovered or naked call, he/she would have to go into the open market to buy the shares to deliver, and the $0.50 per share would become an actual capital loss.

RELATED TERMS
  1. Covered Call

    An options strategy whereby an investor holds a long position ...
  2. Call On A Call

    A type of compound option in which the investor has the right ...
  3. Roll Down

    The replacement of an option with a new option that has a lower ...
  4. American Option

    An option that can be exercised anytime during its life. American ...
  5. Interest Rate Options

    An interest rate option is a financial derivative allowing the ...
  6. Seller

    A seller is an entity who writes an option contract and collects ...
Related Articles
  1. Trading

    Cut Down Option Risk With Covered Calls

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

    The Risks Of Writing Covered Calls

    While writing a covered call option is less risky than writing a naked call option, the strategy is not entirely riskfree.
  3. Trading

    Trade The Covered Call - Without The Stock

    The standard covered call can be used to hedge positions or generate income. This calendar spread may do so more effectively.
  4. 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.
  5. Trading

    Getting Acquainted With Options Trading

    Learn about trading stock options, including some basic options trading terminology.
  6. Trading

    Three Ways to Profit Using Put Options

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

    Going Long On Calls

    Learn how to buy calls and then sell or exercise them to earn a profit.
  8. 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 ...
  9. Investing

    Writing Covered Calls On Dividend Stocks

    Writing covered calls on stocks that pay above-average dividends is a strategy that can be used to boost returns on a portfolio, but it carries some risk.
RELATED FAQS
  1. How Do Speculators Profit From Options?

    Options are a risky game, but you can learn speculators' tricks to use them to your advantage. Read Answer >>
  2. When holding an option through expiration date, are you automatically paid any profits, ...

    Holding an option through the expiration date without selling does not automatically guarantee you profits, but it might ... Read Answer >>
Hot Definitions
  1. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  2. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  3. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  4. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  5. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  6. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
Trading Center