When you have a call option- option to buy and a put option - Option to sell; why would we have a call/put option buyer and call/put option seller? I'm having trouble to understand why can't a call option buyer buy the shares and the same person becomes put option seller to sell the call option he bought earlier ?
3 Answers
Remember that the buyer always has the option to buy or sell, so it makes sense for the transaction to go either way and for the optionality to be on either side, hence 4 different scenarios.
So here are the 4 scenarios:
- Buy a call (have the right to buy at a specific price)
- limited loss (premium), unlimited gain
- Sell a call (have the obligation to sell at a certain price)
- limited gain (premium), unlimited loss
- Buy a put (have the right to sell at a certain price)
- limited loss (premium), unlimited gain (technically limited to stock price minus the premium since price cannot go below 0)
- Sell a put (have the obligation to buy at a certain price)
- limited gain (premium), unlimited loss (technically limited to stock price minus the premium since price cannot go below 0)
In each case, the buyer of the option is going to make the choice that's in their best interest, possibly creating large losses for the seller of the option.
answered May 21, 2018 at 13:19
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The wording in your explanation might be confusing to a noob. There is no right or obligation "above or below" a certain price with an option. The right or the obligation is only 'at' the strike price and that is the price at which the shares transact if assigned or exercised. May 21, 2018 at 19:35
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1@D Stanley - I completely understand. There are times when I read one of my posts and I wonder, who wrote that ??? :->) May 21, 2018 at 19:42
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Upside on buying a put is large relative to the premium, but is limited to stock price in exactly the same way as downside on selling a call. May 23, 2018 at 19:02
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@dave_thompson_085 You're right - and I had the loss on a sold call and on a sold put wrong, too. Good catch. May 23, 2018 at 19:09
If you own a call option for share A and you don't believe any more in a future rise of share A, you don't want to keep your call option.
You suggest to exercise your option and buy the share A. But as you don't believe in rising quotes for A you will not want to invest money in A.
If however you sell your call option you get money for it from someone who thinks that share A will rise in the future.
So your choice is:
- spend more money for share A
- get money for your call option and forget about A
When you own a call option (in the U.S), several things can happen.
Prior to expiration, you can sell it to close the position
If the option is American style, you can exercise the call at any time to acquire the underlying (only at expiration for European style) though it would not make any sense to do so unless the shares were ITM
At expiration, it is out-of-the-money and expires worthless
At expiration, it is in-the-money and is auto exercised
The simplest way to close the contract is to sell to close (#1) because it involves the least amount of commissions and frictional cost. It would make no sense to spend money on a put option to have the right to the underlying shares when you could sell them directly in the market.
You cannot sell a put to cancel out a call (your last sentence). I would suggest that you get a better grasp of what it means to be long or short a call as well as to be long or short a put.
answered May 21, 2018 at 11:29
