Rights Obligations – Key Points About Selling Options Part 2
Rights Obligations – Key Points About Selling Options (Part 2)
From the buyers perspective, what our options holders are trying to accomplish when they purchase an option. Whether it’s a call or a put option, an option buyer is paying money upfront to own the right to execute a particular transaction in shares of stock. Whether its buying or selling shares, it depends on whether they buy a call or a put. But,, ultimately they are purchasing the right to own the choice to execute this particular transaction and they have a market outlook that is either bullish or bearish not neutral.
This investor has an opinion that the stock or underlying is moving higher or it’s moving lower and they’re trying to capitalize on that. To state it more generally, option buyers want movement in the stock price or the underlying price in the direction, in the case of calls, higher and if it’s puts lower. They’re looking for movement, trading firms or professional trading entities might be buying options because they’re trying to purchase volatility in the marketplace with the expectation that it’s going to go higher. That certainly can be a motivation, for most investors that is not the motivation, that type of analysis can be a bit complex involving heavy data feed.
Regarding historical data of the stock price movement the current level of implied volatility historic levels of implied volatility and an analysis of the difference between those. That all goes into a thorough analysis of current volatility levels and where they might be headed. Investors can do it, but the majority of investors who are buying options are looking for movement. The motivation to buy an option is to capture Deltas, or to get long Delta or short Delta in exchange for the time decay. Now, they paid the price up front, that’s the premium and the cost that they incurred what they suffer is the loss of time from one day to the next. The buyer needs movement in the right direction within the right period of time and to a certain magnitude. All of those things have to occur for the option buyer to make money, so buying Delta’s looking for a move one way or the other.
Option sellers have a different motivation, it’s very simple. Option sellers are trying to capture the premium they receive from the options contract. That’s it. And we’ll see in the examples in future slides that more specifically options sellers are looking to capture time value. That extrinsic value in the option contract the part that decays from one day to the next.
That is what options sellers are looking to capture. It’s cash that comes right into their account and along with that the seller or writer of the contract accepts the obligation to take the other side of the buyer. In the case of calls that would be to sell shares at the strike price. If they are required to do so or buy shares at the strike price if they’re required to do so. There’s a significant amount of risk if you just trade these as outright positions. We will have the profit and loss graphs coming up here on the next few slides.
To state it in the same terms as I did from the buyers perspective options sellers give the buyer the Deltas that the buyer wants in exchange for the option premium. There’s different strategies that you can use when you’re selling options in conjunction with buying options or owning shares of stock, but those are the four pieces. You can put them together in many different ways and that would speak to the flexibility of the options product itself and we’ll get into a little bit of that as well.