Call Writing and Put Writing

 Call Writing and Put Writing: Detailed Explanation

Call Writing and Put Writing are strategies used in options trading, a part of derivatives trading. To understand them fully, let’s break them down.

1. What is Options Trading?

Options are financial contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset (like stocks, commodities, or indices) at a predetermined price (called the strike price) before or on a specified date (the expiry date).

• Call Option: Gives the buyer the right to buy an asset.
• Put Option: Gives the buyer the right to sell an asset.

Now, there are two sides to every option trade:

• Buying an Option: Paying a premium to purchase the right to buy/sell the asset.
• Writing (Selling) an Option: Taking the responsibility to sell/buy the asset if the buyer exercises the option.

2. Call Writing

Call Writing (or Selling a Call) is when an individual sells a call option contract. The seller, known as the call writer, is obligated to sell the underlying asset to the call buyer if the buyer decides to exercise the option (usually when the asset price is above the strike price).

Types of Call Writing:

• Covered Call: The call writer owns the underlying asset. This strategy is used to generate additional income on assets the writer already owns.
• Naked (Uncovered) Call: The call writer does not own the underlying asset. This is riskier, as the writer may have to buy the asset at a higher market price if the option is exercised.

Example of Call Writing:

• You sell a Call Option for Stock XYZ with a strike price of $100 and collect a premium of $5 per share (each option typically represents 100 shares, so total premium = $500).
• If the stock stays below $100, the buyer won’t exercise the option, and you keep the $500 premium as profit.
• If the stock rises above $100, the buyer will exercise the option, and you are obligated to sell XYZ at $100 (even if it’s trading at $110 or more), potentially incurring a loss if you don't already own the stock.

Key Points:

• Profit: The premium received from selling the call.
• Risk: If the stock price rises sharply, your losses can be significant because you’ll have to sell the stock at the strike price (if you don’t own the stock, you’ll have to buy it at the market price first, which could be much higher).

3. Put Writing

Put Writing (or Selling a Put) is when an individual sells a put option contract. The seller, known as the put writer, is obligated to buy the underlying asset from the put buyer if the buyer exercises the option (usually when the asset price is below the strike price).

Types of Put Writing:

• Cash-Secured Put: The put writer has enough cash in their account to buy the underlying asset if the option is exercised. This is a common strategy for acquiring stocks at a discount.
• Naked (Unsecured) Put: The put writer does not have enough cash to cover the purchase of the asset. This is a riskier strategy since it requires the writer to have enough liquidity in case the option is exercised.

Example of Put Writing:

• You sell a Put Option for Stock XYZ with a strike price of $100 and collect a premium of $5 per share (total premium = $500).
• If the stock stays above $100, the option expires worthless, and you keep the premium.
• If the stock falls below $100 (e.g., to $90), the buyer exercises the option, and you are obligated to buy XYZ at $100, even though the market price is lower.

Key Points:

• Profit: The premium received from selling the put.
• Risk: If the stock price drops sharply, you could be forced to buy the stock at a price higher than the market price, leading to a potential loss.

4. Comparison of Call Writing and Put Writing

Feature	Call Writing	Put Writing
Obligation	Sell the asset if option is exercised	Buy the asset if option is exercised
When Profitable	When the asset price stays below the strike price	When the asset price stays above the strike price
Risk	Losses if the asset price rises sharply	Losses if the asset price falls sharply
Strategy Objective	Income generation, hedge positions	Acquiring stock at a discount or generating income
Maximum Profit	Premium received	Premium received
Maximum Loss	Unlimited (if uncovered)	Limited to the strike price minus premium

5. Example:

Call Writing Example:

• Stock XYZ is currently trading at $95.
• You sell a call option with a strike price of $100 and receive a $5 premium.
• If XYZ remains below $100, you keep the $5 premium.
• If XYZ rises above $100 (let’s say $110), you are forced to sell the stock at $100, missing out on the $10 price rise.

Put Writing Example:

• Stock XYZ is currently trading at $105.
• You sell a put option with a strike price of $100 and receive a $5 premium.
• If XYZ remains above $100, you keep the $5 premium.
• If XYZ drops below $100 (let’s say to $90), you are forced to buy the stock at $100, incurring a $10 per share loss (offset slightly by the $5 premium).

Conclusion:

• Call Writing is best for generating income in a neutral to slightly bearish market, but has significant risks in a bullish market if uncovered.
• Put Writing is used to either buy stocks at a discount or generate income in a neutral to slightly bullish market, with risk coming from sharp market declines.

Both strategies are commonly used by investors and traders for income generation or for entering stock positions at favorable prices, but they require careful risk management.