What are the Best Tips for Writing Call Options?

Jim B.

Writing call options is the process by which an investor promises to sell a buyer 100 shares of an underlying security if the stock price of the security rises above a certain point before the option expires. The option writer is essentially the option seller, who earns money from the premium paid for the option but can lose it if the price rises above the strike price, which is the price above the current price at which the buyer can exercise the option. When writing call options, investors must be wary of stocks that show great volatility and thus have the potential to rise quickly. Manipulating strike prices and covering the call options by buying the underlying stock are other strategies for option writers.

Man climbing a rope
Man climbing a rope

A stock option gives the buyer the opportunity, though not the obligation, to buy 100 shares of an underlying stock. If the price rises above the strike price before the expiration date, the buyer of the option can gain a profit by either exercising the option and buying the shares or selling the option back on the market. The seller, or writer, benefits by pocketing the premium paid for the option, but can suffer significant losses if the price rises. For that reason, writing call options are a precarious practice and require guts and strategy.

Investors writing call options should steer clear of stocks that show volatility, as they are inclined to sudden rises and falls. Since an option writer can only gain from the premium paid by the buyer, it doesn't really matter to him how far the underlying stock falls as long as it stays below the strike price. A big spike in the price can be devastating to an options writer, so technical analysis that judges volatility of stocks should be performed before such a practice is attempted.

If an investor believes with extreme certainty that the price of the underlying security will drop, she may try a naked sell, which means that she borrows the shares to sell without actually owning the stock. This is extremely risky, so a safer method of writing call options is the covered sell. With a covered sell, the writer actually buys, or owns beforehand, the stock underlying the option. In this way, she can offset the losses of a price rise with the increased value of the stocks, a technique known as hedging.

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The strike price is extremely crucial to writing call options, as it is a level that the writer can adjust to protect his investment and make a bigger profit. Option writers who believe that the underlying stock is stagnant can keep the strike price low, which means the buyer must pay a higher premium. A safer choice would be to keep the strike price high, which would keep the premium down but increase the chances that the stock stays out of the money and the seller doesn't suffer losses.

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