DEFINITION of Writer
A writer (sometimes referred to as a grantor) is the seller of an option who opens a position to collect a premium payment from the buyer. Writers can sell call or put options that are covered or uncovered. An uncovered position is also referred to as a naked option. For example, the owner of 100 shares of stock can sell a call option on those shares to collect a premium from the buyer of the option; the position is covered because the writer owns the stock that underlies the option and has agreed to sell those shares at the strike price of the contract.
BREAKING DOWN Writer
An option is uncovered when the writer does not have an offsetting position in the account. For example, the writer of a put option, who agrees to buy shares at the contract’s strike price, is uncovered if there is not a corresponding short position to offset the risk of buying shares.
The primary objective for option writers is to generate income by collecting premiums when contracts are sold to open a position. The largest gains occur when contracts that have been sold expire out of the money. For call writers, options expire out of the money when the share price closes below the strike price of the contract. Out-of- the-money puts expire when the price of the underlying shares closes above the strike price. In both situations, the writer keeps the entire premium received for the sale of the contracts.
Covered writing is considered to be a conservative strategy for generating income. Uncovered or naked option writing is highly speculative because of the potential for unlimited losses.
Covered call writing generally results in one of three outcomes. When the options expire worthless, the writer keeps the entire premium and can write options again to generate income. If the options expire in the money, the writer can either let the underlying shares be called away at the strike price or buy the option to close the position.
The outcomes of writing uncovered calls are generally the same with one key difference. If the share price closes in the money, the writer must either buy stock on the open market to deliver shares to the option buyer or close the position. The loss is determined by the cost of buying stock over the strike price or closing the option position, minus the premium received when the position was opened.
When a put writer is short the underlying stock, the position is covered if there is a corresponding number of shares sold short in the account. In the event the short option closes in the money, the short position offsets the loss of buying the shares. In an uncovered position, the writer must either buy shares at the strike price or buy the position to close. The loss is the difference between the market value of the shares and the strike price or the cost of closing the position, minus the initial premium.