A writer 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 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.
An option is uncovered when the writer does not have an offsetting position in the account. 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 due to 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. Dictionary Term Of The Day. A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews.
Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Call Writing Covered call writing generally results in one of three outcomes. Put Writing 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.
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