2

Some option strategies such as bear put spread are inherently "loss-limited", meaning that you know in advance your maximum loss.

As an example, if I buy 10 put options for $100 and sell 10 put options (with a lower strike) for $90, then my maximum potential loss in a worst-case scenario would be $100 (and the fees).

At least that's what they say in the books.

I've been thinking if there are any hidden risks with selling options but could only imagine a collapse of the clearing house due to war or other devastating event. But maybe I'm wrong?.. What bugs me is that potential losses while selling options are unlimited. Could there be anything that might prevent my long put from being exercised, but still allow the short put to be exercised (and cost me an arm and a leg)?

I'm talking about European-style options in an EU country, if that matters.

  • 1
    Expiration risk such as you suggest can occur with American options since they are settled with the underlying. – Bob Baerker Mar 26 at 0:26
2

No, in the situations you're describing with spreads, European options and "loss-limiting strategies" there is no hidden risk of your short put being exercised against you, and somehow not being able to exercise your long put. The strategies are designed in this manner so you're aware of your max loss when putting on the strategy.

In any event, you could always dodge a short option being exercised against you since, by construction, European options can only be exercised at expiration (opposed to American options which can be exercised at any point before or on the expiration date).

Potential losses while selling options are unlimited, but can be easily limited to a specific bound by using a hedge (e.g., using proceeds/credit from sale of option to buy options, such as a spread).

| improve this answer | |

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.