The Stock Market

Option Writers

In the example, David’s parents wrote the options. In the real world, however, anyone can write stock options. While David’s father wrote an option abd gave it to him for free, the people who write options usually sell them. An option like the one that David’s father can cost $5, $10, $50, or even more.

Where Options Come From


An Option Writers Profit or Loss

Introduction

An option writer, regardless of whether he writes a call or put option, accepts a liability by which he can only lose (or break even). In exchange for this liability, he demands payment in the form of the option’s initial price. The larger his expected loss, then the higher the price he charges for the option.

An option holder cannot lose money from the option itself - he can only gain (or break even). The more he thinks he will gain, then the more that he is willing to pay for the option.

Profit

The most an option writer can gain from an option is its selling price. For example, if he sells an option for $10, then in the best-case scenario (in which the option holder does not exercise it), the option writer will make a $10 profit.

The maximum loss on a call option

The option writer’s potential loss is unlimited. For example, if someone writes a call option for an ounce of gold at $400, then sells the option for $10 as the price of gold climbs to $1,000, he will lose $590 ($600-$10). If the price reaches $2,000, then he loses $1,590.

The maximum loss on a put option

A writer of a put option can at most lose the value of the strike price. This happens if the value of the underlying asset drops all the way to zero. It is evident that the option writer’s potential loss is great. Large institutions, such as banks and corporations, therefore write the vast majority of options.

Option Writers 530Option Writers