OPTION Basics (3) (CALL and PUT - Sellers' Perspective)

Now, we turn our attention towards “sellers” perspectives.

Call Option

Sell Call: When an investor sells a Call, he is selling the right to Call buyer, or granting the Call buyer the right to buy 100 shares of the underlying stock at the striking price from him, any time prior to the expiration. Another way of putting it is the seller is obligated to sell 100 shares of the underlying stock to the Call buyer at the strike price.

In contrast to the Call buyers, Call sellers collect the premiums.

Example 1:

Mr. A sells “1 AIG Aug 12 Call at $1.50”.

Mr. A is selling the right to the Call buyer, say Mr.B, to purchase 100 shares of AIG at the price of $12/share between the point of transaction till the expiry date from Mr. A.

The call seller, Mr. A would collect the $1.50/share (the premium).

Suppose at the end of the expiration, AIG stock was traded at $10/share, the option would expire worthless and the Call seller, Mr.A, would earn the full premium.

So a Call seller is bearish on the stock. He will earn the full premium if the shares expire below the strike price.

Uncovered Calls/Covered Calls

When you sell a call but you do not own 100 shares of the underlying stock, this option is call “naked option”; “uncovered option” or “uncovered call”. This type of trade is extremely risky as the share price could have unlimited up side.

Given the earlier example:

Mr. A sells “1 AIG Aug 12 Call at $1.50”.

Suppose the share of AIG has gone up to $30/share. The buyer exercises the option. Mr. A needs to buy 100 shares of AIG from the market at $30/share and sell them to the Call buyer at $12/share.

Thus for Call seller, it is always good to own 100 shares of the underlying stock.

So when you own the 100 share of the underlying stock and when you sell the Call, you are covering your position. Such trade is called “Covered Calls”
Put Option

Sell Put: When you sell a Put, you are granting the Put buyer to sell you 100 shares of the underlying stock at the strike price. Should the Put is exercised, you are obligated to buy 100 shares from the Put buyer. 

Put sellers collect premium.

Example 2:

Mr. A sells “1 AIG Aug 12 Put at $1.50”.

Mr. A is granting the Put buyer to sell him 100 shares of AIG at $12/share.

Suppose at the end of the expiration, AIG stock has risen to $15/share. The option would expire worthless and Mr.A would collect the full premium.

Thus, Put seller is bullish on the stock. He hopes that the share price would close above the strike price, thus the option would expires worthless so that he could collect the premium.

Week of Oct 19, 2009

Exactly a week ago, I sold an AIG Nov 45 Call @ $4.85. AIG was traded at high $43 then. Thanks to recent drop, I closed this call today at $2.87. A net gain of ~4% in a week. I am quite happy with this trade even though I am fully aware that potentially AIG could drop further from here. I am trying to lock in on the profit for my Nov target. 

On a separate note, I sold STP Dec 16 Put @ $2.05. This is a potential 5.5%/month gain. Hope my choice is right.

Oct 16, 09

Back in end of Aug, I wrote a AIG Nov 33 Put @ $5.50. It was the first trade I made that is longer than one month. I decided to close this today @ $0.82. All in all a net of 13.53% in a month and a half. I am quite happy with this. If I hold my other Nov trades even, I would have basically achieved my Nov target. Additional gain would be the icing on the cake. I have a AIG Nov 45 Call and STP Nov 16 Put. My AIG is in green where as STP is in red. Let's see what happens.

In the mean time, I just wrote STP Dec 14 Put @ $1.25.

Week of Oct 12, 2009

This week is the last week for Oct expiration. I have two open trades. C Oct 5 Put @ $0.63 and STP Oct 16 Put @ $1.63. Unfortunately both are in the money, but fortunately, if both stocks could hold at their current level, I would still be in the green. I am looking forward to Nov as I have an AIG Nov 33 Put @ $5.50. Also, I wrote AIG Jan 35 Put @ $5.95. As you can see, I am rather conservative if you may say, or "chicken". I tend to write quite far out of the money. I am trying to minimize my risk to hope to achieve average of 3% or more return monthly through option writing. So far, I made loss in July -2%; +5% in Aug; +6% in Sept; +1% in Oct. Will see how Nov goes.

Also, I have been sitting on 100 shares of AIG and have not had a chance to utilize it, till today. I decided to write AIG Nov 45 Call @ $4.85. It is kind of risky as we are in the midst earning season. But, it could go either way as I see the outlook is still uncertain. Should AIG goes up, I will need to see if I want to give up my shares or roll forward.

10/15/09:
It is too unfortunate that market has given in on the recent up trend just a couple of days before the Oct expiration. I just closed my C Oct 5 Put @ $0.25, which I opened @ $0.63. About 6% net. I also closed my STP Oct 16 Put @ $1.00 (~2.5% net).
For STP, I did a spread to roll over to Nov @$1.7.

OPTION Basics (2) (CALL and PUT)

There are essentially two types of options:

1. Call Option

2. Put Option

For each of the Call/Put, there will be buyer and seller. Let us look into each of the scenario. We will go through “buyer” perspective for both Call and Put before touching on “seller” perspective.

Call Option

Buy Call: When an investor buys a Call, he is buying the right to purchase the underlying stock (100 shares) at the specified fixed price (strike price) by the specified date (expiration) in the future. To re-iterate the examples given.

Example 1:

Mr. A buys “1 AIG Aug 12 Call at $1.50”.

Mr. A is buying the right to purchase 100 shares of AIG at the price of $12/share between the point of transaction till the expiry date.

Mr. A pays $1.50/share (the premium) to attain this right.

So a Call buyer would profit if the share price goes up. A Call buyer is bullish on the stock.

Suppose at the end of the expiration, AIG stock has risen to $17/share, the buyer would close the transaction and make $5 gain ($17-$12) on the stock, “EXCLUDING” transaction fees and premium paid.

Put Option

Buy Put: When an investor is buying a Put, he is buying the right to “sell” the underlying stock (100 shares) at the specified fixed price (strike price) by the specified date (expiration) in the future.

Example 2:

Mr. A buys “1 AIG Aug 12 Put at $1.50”.

Mr. A is buying the right to Sell 100 shares of AIG at the price of $12/share between the point of transaction till the expiry date.

Contrary of buyer of Call, the buyer of Put is bearish of the stock. A Put buyer would profit if the share price drop.

Suppose at the end of the expiration, AIG stock has dropped to $9/share, the buyer would close the transaction and make $3 gain ($12-$9) on the stock, “EXCLUDING” transaction fees and premium paid.

On my next post, I will touch on sellers' perspective for both CALL and PUT.

Week of Sept 21, 2009

What a day for AIG. No trade for today, but I would like to mention that both my AIG Sept 15 and 19 Put had yielded 5.5% and 6.5% respectively. My initial target is have and average of 3% to 4% return monthly. So far I am still there on my monthly target.

Week of Sept 14, 2009

Oh well...I been out for a few weeks...

Lets see what's new. Well, I closed C Sept 4 Put @$0.04 (bought at $0.34), resulted a net of 5.88%, based on my calculation (minus fees etc)

Also, I wrote AIG Nov 33 Put @ $5.50 back when AIG was at $45, premium is now at $6.70. Now that didn't go well. :(

Today, I did a spread. Bought to close my STP Sept 16 Put @ $0.92 (sold at $1.10). Still a loss but minimal. I wrote STP Oct 16 Put @ $1.63.

Hope I am back for more as been really busy with work and was really not able to focus...