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I have some basic knowledge of how options operate. I have limited practical experience buying calls, and puts. I never tried shorting options, and before doing so, wanted to clarify some basic questions.

  1. am I right that terms “short selling” and “writing” in case of options mean the same thing?
  2. in my brokerage account (interactive brokers), I don’t see anything like “write option”. I see only “buy” and “sell”. So, if sell an option that I don't own, I basically “write” it?
  3. am I right that: when I sell options (that I don’t have), nothing like borrowing happens (like in short-selling stocks, when behind the scenes you borrow stocks from someone else).
  4. am I right that: when I sell options (that I don’t have), I “create” them?

And the last question:

  1. Let's say stock FOO trades at price $P. I sold 10 out of the money put options with the strike price $S < $P. Now, when I login to my IB account, I’m seeing smith like “FOO (put $S) -10” indicating that I have a short position of size -10. One day stock price drops below $S to price $T < $S The put options holder now decides to exercise all 10 options and sells 10 x 100 = 1000 stocks at price $S to me. I’m obliged to buy them. In that case, am I right, that if I login to my IB account I’ll observe that:
  • I no longer hold FOO (put $S) -10” position
  • Instead there will be a long position of stock FOO +1000
  • I'll also observe that I have less cash, because I was obliged to buy 1000 of FOO stocks

So, those changes will happen to my account even though I didn't do any actions myself? simply because somebody exercised options that I wrote?

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2 Answers 2

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  1. In options it's just "selling". "Short selling" is more commonly used to describe borrowing securities and selling them, so you owe (are "short") the securities. With options you just buy and sell contracts. But "sell" is the same as "write". And if you sell to open a position you are "short" the option.

  2. Yes

  3. Yes

  4. Possibly, but it really doesn't matter. You may be selling a contract to somebody that is closing out a position, so no new contract is created. But that's just minutia of the options market and isn't pertinent to your activity.

  5. It's much more common that the holder of the option will sell it rather than exercise it. Options are almost always worth more than the profit that is made by exercising them. In that case, their option will be sold to a different participant, again all transparent to you. But yes, if your short put option is exercised you are obligated to buy the security. But, just like the holder is better off selling, exercising early will almost always be a smaller loss than if you were forced to buy back the option for some reason.

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  • thanks for additional notes on 1, 4, and 5. 1 and 4 are clear, but wanted to clarify the 5th. "Options are almost always worth more than the profit that is made by exercising them" -> this part is clear (my understanding, because of the extrinsic value) "But, just like the holder is better off selling, exercising early will almost always be a smaller loss than if you were forced to buy back the option for some reason" - this is confusing. Are you saying that instead of waiting for put option to be exercised at expiration date, it is practically better to close position before that? Jun 30 at 0:55
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    Not necessarily. I'm saying it you are exercised, it's better than if the position were sold out from under you (which can't happen).
    – D Stanley
    Jun 30 at 2:40
  • >Buy "sell" is the same as "write"< Typo? BY? Be that as it may, they're the same when opening a contract but not when closing. Jul 10 at 18:56
  • @govordovsky - If an option has time premium remaining, it makes more sense for the owner to sell the option because exercising it throws away the time premium. The exception to this is when an option is in-the-money and the bid is less than the intrinsic value. This tends to occur before dividends and/or near expiration. When to close an option is primarily a function your outlook for the underlying. Jul 10 at 19:02
  • @BobBaerker "Buy" --> "But". Thanks, fixed.
    – D Stanley
    Jul 10 at 21:44
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Yes, yes, yes, yes, and yes.
When you write / short sell an option, you are assumed to know what you are doing, and what the potential consequences are.

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  • ty. yeah, I'm not talking about the risks, and potential losses. Just wanted to clarify how things operate. The last question amuses me the most. Basically, one day I can just see that short option position is gone, and instead I got long stock position. Jun 30 at 0:25
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    You are supposed to get emails or texts or whatever you usually get saying that the option were exercised, with all the details. Normally, nobody exercises options except on their last day's closing; as exercising them before is burning money (he could always sell them instead for more money).
    – Aganju
    Jun 30 at 0:28

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