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Why sell or write a call option ?


Due to high volatility and India VIX is sustaining above the range, we are seeing some abrupt directional moves in the market. However, the market goes and shifts between trends namely Uptrends, Downtrends and Sideways. Most of the time market remains in a range or consolidates. 

And this is the time where sellers hit the most of the market. As the consolidating market, boost them up. This does not mean, they only sell in a ranging market. They always sell but love the range. The fact is most of the time market consolidates that’s the reason the 65 per cent of an option expire worthless what the option sellers love.

Option selling has an unlimited risk but limited profit but mathematically they have an upper hand over buyers as if someone sells a call, he believes the market will go down. There are two out of three conditions in which he can make a profit. 
1. If the market goes down, and his option expires out of the money.
2. If the market consolidates - here he gets the benefits from theta decay.

He makes a loss only one condition that is the market goes against his believes. As we discussed above the market moves in three directions, and out of these directions, sellers can make money in two conditions. The third condition in which sellers make a loss, is the condition where buyers win the game so option buying is an art as you have little chance to win - only 33% times buyer win the game and 66% times sellers celebrate. 

An option trading is a Zero-sum game if sellers lose then the buyers win. 66% per cent time sellers win the market by selling the perfect option.

Option Buyers Vs Option Sellers
· If the option buyer has limited risk (to the extent of the premium paid), then the option seller has limited profit (again to the extent of the premium he receives).
· If the option buyer has unlimited profit potential then the option seller potentially has unlimited risk.
· If the option buyer is making Rs.X in profit, then it implies the option seller is making a loss of Rs.X.
· If the option buyer is losing Rs.X, then it implies the option seller is making Rs.X in profits.
· Lastly, if the option buyer thinks that the market price will increase (above the strike price to be particular) then the option seller would believe that the market will stay at or below the strike price, and vice versa.


Buyers
Sellers
Risk
Limited
Unlimited
Profit
Unlimited
Limited
Opinion about Market
UP
Down/Sideways
Opinion
Down
Up/Sideways
Zero-Sum
+X
-X
Call option seller's thought process
· The price of the land moves above Rs.40,00,000 (good for You– option buyer (Home Buyer in our example).
· The price stays flat at Rs.40,00,000 (good for Developer– option seller).
· The price moves lower than Rs.500,000 (good for Developer– option seller).
· If you notice, the option buyer has a statistical disadvantage when he buys options – only 1 possible scenario out of the three benefits the option buyer. 
· In other words, 2 out of the 3 scenarios benefit the option seller. This is just one of the incentives for the option writer to sell options.
· Besides this natural statistical edge, if the option seller also has a good market insight then the chances of the option seller being profitable are quite high.
Understanding Call Sell with Option Chain

· As we can see the stock is trading at Rs. 376 (highlighted in Green).
·  I will choose to sell the 360 strike call option by paying a premium of Rs. 6.2/- (highlighted in Blue box and arrow). 
P&L behaviour of Call Sell  (upon expiry)


Spot
Premium Received
Intrinsic Value (IV)
P&L (Premium – IV)
370
6.2
370-400 = 0
6.2
375
6.2
375-400 = 0
6.2
380
6.2
380-400 = 0
6.2
385
6.2
385-400=0
6.2
390
6.2
390 - 400 = 0
6.2
395
6.2
395 - 400 = 0
6.2
400
6.2
400 - 400 = 0
6.2
405
6.2
405 - 400 = 5
1.2
410
6.2
410 - 400 = 10
- 3.8
415
6.2
415 - 400 = 15
-8.8
420
6.2
420 - 400 = 20
-13.8

Call option Seller’s P&L payoff

· The profit is restricted to Rs.6.35/- as long as the spot price is trading at any price below the strike of 400
· From 400 to 405 (breakdown price) we can see the profits getting minimized.
· Above 405 the call option seller starts losing money. In fact, the slope of the P&L line clearly indicates that the losses start to increase exponentially as and when the spot value moves away from the strike price.


Key Findings
· The call option writer experiences a maximum profit to the extent of the premium received as long as the spot price remains at or below the strike price (for a call option).
· The option writer experiences an exponential loss as and when Star starts to move above the strike price of 400.
· The call option writer starts to lose money as and when the spot price moves over and above the strike price. Higher the spot price moves away from the strike price, larger the loss.
· From this example, you can understand how sellers have the unlimited risk.
Why sell or write a call option ? Reviewed by Kumar Chandan on April 03, 2020 Rating: 5

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