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I am a US citizen living in the US. I want to write covered call options to receive premiums. If implied volatility increases and/or the price of the underlying rises, an out-of-the-money call can increase in value.

Does this increase in value of the option pose a risk to me as the writer? Or is the risk exclusively associated with exercise of the option when it is in-the-money? Am I totally safe from risk if the option remains out-of-the-money (the stock price is lower than the call's strike price) from the time it is written until expiration, even if the movement of the stock/IV rises the price of the option in the intermediate time frame?

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If the price of the contracts rise, it's a "paper loss", meaning a position you hold has incurred a loss, but it isn't locked in unless you make a transaction. If you were to close the position in that exact moment, then of course you would incur losses. But if you hold out long enough or eventually to expiration, the price will eventually approach zero and become worthless at expiration.

So, there is no other risk to worry about, except for the position expiring while ITM.

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You did not indicate what overall strategy you are employing and that determines the answer.

If this is a covered call, there are no consequences if implied volatility increases. The risks that a covered call writer face are opportunity risk (the call is assigned and you miss out on the security's gain above the strike price) and the asymmetric risk of receiving a small premium while bearing all of the downside risk of stock ownership (less the premium received).

If this is a naked call then not only do you face unbounded upside risk but your margin requirement can increase significantly due to share price change.

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  • I appreciate this explanation. The call is to be covered. However, my question also assumed the option remained out of the money, never rising above strike before expiration. Is there still a risk with a naked call if this remains the case? Obviously there is no guarantee of this, but just assume that that is the case – Runeaway3 Aug 3 '20 at 18:39
  • To keep it simple, assume that it's expiration and there's no time premium remaining. For every dollar that the stock is above the strike price, there will be $1 of intrinsic value. If the call is naked, you're losing that amount. $5 ITM? You've lost $5 less the premium received. Therefore, you have unbounded loss on your short call to the upside. However, if you own the stock, above the call's strike price you're making $1 on the stock for every $1 you lose on the short call so therefore, the maximum that you can make on a covered call is the strike price plus the premium received. – Bob Baerker Aug 3 '20 at 19:35
  • I understand the concept. My question is underlyingly asking about the feasibility/risk involved with writing absurdly OTM calls prior to some known-date major event (ie highly anticipated earnings) with the hope someone will buy the option anyway. Likely they will get IV crushed, but I'm wondering what the risk is to me if the earnings beat expectations and the stock rises a lot (and therefore so does the option), but NOT above the strike. I still lose no money in that situation, correct? Yes the option has risen in price, but not enough to be exercised. No loss to me there? – Runeaway3 Aug 3 '20 at 22:32
  • If the stock is below the strike at expiration, the call expires worthless and you keep the premium. Period. However, there are scenarios where if there's time remaining and not as much IV crush as expectedand share price movement, you may never have the chance to get out without a loss. I spent a good number of years selling high IV earnings announcement premium. It shouldn't be done unless you really understand the game. If you're going to chase implied volatility, consider hedging so that you have some inherent damage control (verticals, diagonals, iron coders, diagonal iron condors, etc) – Bob Baerker Aug 3 '20 at 23:07
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    Asked and answered (3 times) – Bob Baerker Aug 4 '20 at 1:21

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