Comments (37)

Peter

November 16th, 2011 at 7:46pm

Mmm..yeah, not too sure. I could guess and say that the $178 is the loss between the sold price and the current market price, however, you say 0.27 is the current price? Unless the position is valued against a price other than 0.27 - say average of the bid/ask spread or last, which may be some other price.

Then I would have said that the $280 was the loss including commissions. But that would suggest that you pay approximately $10 per contract in brokerage. What are your rates?

By the time the option expires, if it is still out-of-the-money, then the price of the option will have traded from 0.27 to zero so the unrealized losses will have been credited back into your account and you will be left with the $110 credit from the initial sale (minus brokerage fees).

Mark

November 16th, 2011 at 6:11pm

Sorry I guess I should have mentioned that I purchased 10 option contracts

Mark

November 16th, 2011 at 6:06pm

Thanks for the quick reply Peter. I am using Etrade as the broker. I do see the margin of 4400 or so where there are accounting for what you are talking about.I am hoping that it doesnt have to get excerised and my concern is why the show of a loos. when I looked at the position in my main account it does show a market value loss of -$280 however in my trader platform it shows a loss of -$178. The strike price for the option I bought is 119 which expires in a few days. Assuming we never get that low by the end of the week, say maybe 121, which would still showing a loss. What happens to the loss? Do i still get the premium?

Peter

November 16th, 2011 at 5:23pm

Hi Mark,

When you initially sold the put, $11 would have been credited to your account. But your position will be revalued according to the current market prices, so with the option now at 0.27 you would have a $16 loss on the position.

However, because you are short a naked option your broker will also deduct some money from your account as a margin in case you are exercised and have to take delivery of the underlying position. In this case, as it is an index, there won't be an exercise so the margin is used as a buffer against a large loss.

Is there a way that you can see the transaction breakdown to confirm? What broker do you use?

Mark

November 16th, 2011 at 4:06pm

Hi Peter

I sold a naked put today... (sell to open a put OTM for SPY) It was the 119 nov put and i sold it for .11. I just wanted the premium for it. The market went down today and that same put is now .27. It is now showing a loss in my positions of about $180. Is this normal. I am assuming i can let this expire but what about the loss, dows it expire with the option?. Is it charged to me? because I dont see a premium recieved anywhere on my site.

Peter

September 7th, 2011 at 7:48pm

Yes, you're right - the $5 put vs the $5 call implies a forward price for the stock of $3.13. I'm not sure why. I thought at first that it could be because of a dividend but the company has never paid a dividend and a $2.17 per share dividend seems a bit unrealistic.

I've asked a friend of mine who is a market maker for Australian stock options if he has any ideas and I'll reply when/if I find out.

Sam

September 6th, 2011 at 1:42am

Thanks, Peter.

As I can see, the market is not that simple ir practice. If you take LDK solar, the put options are severly overpriced. Current stock price is $5,3, and December calls/ puts with strike price 5 are $0,7/$2,3 and the put is not even ITM...

The problem is that it is difficult to get the stock short, so you can't really hedge fully. Anyway, a week ago it was possible to form a position of -100 stocks, +2 calls and -1 put with guaranteed profits of ~ 18% in four months, the only problem is that you can't really go short easily :)

And i guess you can't be sure you will profit since the short might be recalled anytime.. Not a perfect market

Peter

September 5th, 2011 at 5:34pm

Hi Sam, no you are right. This would present an arbitrage opportunity. Calls and puts must be priced according to the put call parity theorem.

This states that Call - Put = Stock - Strike.

Read more about put call parity here.

Sam

September 1st, 2011 at 6:24am

Thank you, Peter. One more thing that is on my mind:

If ATM call and put options are traded at a huge difference, might there be an arbitrage opportunity?

Lets say:
the stock is at $10
$10 call trades at $1
while 10 put trades at $5

As I understand, they should trade close to each other.. What is my mistake?

In this example, if you short the stock, long 2 calls and short the put, you will fully hedge yourself and stay long with profits from an increase in price.

here is an improvised table based on the numbers. Am I missing something?

0 5 10 15 20 stock price

10 5 0 -5 -10 short the stock
-2 -2 0 10 20 long 2 calls
-5 0 5 5 5 short 1 put

3 3 5 10 15 RESULT

Based on these prises (if you are able to find this misspricing), you get a quaranteed hedged profit with it going up if the prices go up. I AM PUZZLED, so please tell me where is my mistake :) Thank you in advance :)

Peter

September 1st, 2011 at 2:13am

Because you've sold the put your risk is that the market goes down and the buyer of the option exercises it.

If the put buyer exercises his/her option then you are obliged to buy the stock from him/her at the strike price.

So, in your case, if exercised you would have to take delivery of the stock at $10 and pay $1,000 per contract ( 10 x 100).

You would, however, keep the premium received when you initially sold the put option.

Sam

September 1st, 2011 at 2:04am

Hi, I am a bit confused now:
let's say I short a put with a strike price of 10. Isn't the maximum loss I can take is -10 per share minus the premium (-1000 per contract)? In the same way as the put has a limited profit payout?

Are there any other points I need to look into? How do options react to splits, bankruptcy and so on?
I am pretty new in options trading, and sold a put with the plan to hold it until expiry, what are the risks involved?

Peter

August 9th, 2011 at 4:06am

ha ha, it's no problem!

1. If you need to calculate the premium of an option then you will need to first understand the mechanics of option pricing. Then you will need a calculator - you can download my option spreadsheet, which calculates an option's fair value.

However, you'll probably not need to calculate the option price yourself - the bids and offers in the market are what you'll be buying and selling against anyway.

2. Yes. If the order is still in the market waiting to be filled, the trader can just remove the order before it is filled if s/he changes his/her mind.

3. Yes. There is a screen shot on this page that shows what we call an option chain.

4. Yes. But it depends on the platform that you're trading with. I use Interactive Brokers and they have a "reverse position" button that if you click it opens up an order ticket to do the opposite of your existing position.

Nat

August 9th, 2011 at 12:37am

Hello Peter,

I just hate myself for bothering you again, but you seem to be the perfect options teacher. I have 4 questions as follows?

1. How do you calculate the premium of the option?
2. If the seller of the option realizes that he doesn't want to sell his option although he has placed a sale order, but no one has bought it yet, can he cancel his sale?
3. When the buyer enters the trading platform (goes into the market to do his shopping), does he see a list of option contracts offered at different prices? Then he chooses to buy the one he wants that meet his specification, by placing an order?
4. When offsetting the position, do you simply place a sale or purchase order? There is no specific offset button, right?

Thank you so much and I hope that I don't have to bother you anymore after this.

Peter

August 8th, 2011 at 7:59pm

Correct. Although technically, you don't actually "pay" a margin to the broker. The margin amount is "allocated" from your account by your broker in case you incur a large loss. The difference is that you should still earn interest on the margin.

Nat

August 8th, 2011 at 7:28pm

Hello Peter,

I think I understand almost everything now, thanks to your explanation. One last question is, if the seller of the put option (or call option) offsets his position, when he does that does the margin that he has placed with the broker get returned to him after he closes his position?
Thank you.

Peter

August 8th, 2011 at 1:48am

Kind of - although the buyers and sellers at the time of the transaction are not necessarily the ones to swap obligations for delivery.

If an option buyer decides to exercise, then the clearer will choose (at random I believe) a participant who has a short option position to exercise.

This process is called novation.

Nat

August 8th, 2011 at 12:28am

Do you mean that the seller (let's call him seller a) buys it back from any seller (in this case, let's call him seller b) in the market? Then, seller b (the person he bought the option from) will be obliged to buy from the original buyer whom he sold his put option to in the first place instead of him? Is that how seller a closes out his position and exits any obligations that he has on him?

Thank you and sorry for taking so much of your time. You have been most helpful to me.

Peter

August 7th, 2011 at 7:55pm

A short position is offset in the same way that a long position is - by doing the opposite trade. In this case by buying the same option contract back from a seller in the market.

Nat

August 7th, 2011 at 7:35pm

Hello Peter,

Now I am confused about how the seller of a put closes out his position. He will buy the same contract with the same strike price and expiry date to offset the one he sold. Now, who does he buy it from and how does this close out his position as the seller of the put contract and leaves him with no obligation?

Thank you once gain for your help.

Peter

July 14th, 2011 at 10:56pm

Hi Larry, the term "naked" is used to describe an option position where you don't have any downside/upside protection. In the case of a short put it is referred to as "naked" because your risk as the market sells off continues all the way until the market reaches zero.

Larry

July 14th, 2011 at 9:40pm

I don't understand what you mean by naked when you state "selling naked puts..." in your description above. I understood that by selling a put option I might have the stock "put" to me at the strike price of the option, but I don't see what I'm "naked" of.

Peter

October 25th, 2010 at 7:20pm

Some solid tips there Joel...thanks!

When you say 50/200 trend zone...are these simple moving averages?

Joel

October 25th, 2010 at 5:41pm

I agree that selling the put is a good way to buy the stock for a bit less than the current selling price - in other words, to take advantage of a dip during the option period. I'm using this to buy strong dividend paying stocks at a discount if they are above the 50/200 day trend line, and I want to own that stock anyway - as Mjasko noted about Goodyear.

So the strategy for dealing with otherwise idle and unneeded cash that is sitting besides an otherwise fully diversified portfolio:

1 - find a reliable stock you want to own that also pays a good dividend - Motley Fool Income report has many suggestions, as do other sources/articles.
2 - understand the stock's valuation, making sure it has room to rise
3 - look at the 'technical' chart (e.g., on Yahoo) and see the zone between the 50-day and 200-day trend lines. If you're basically bullish on the stock, you'll want to buy between them, expecting a bounce at or above the 200 day line.
4 - Look at the next dividend date
5 - If the current price is within the 50/200 day zone, buy the stock and sell a covered call (Buy-Write); you've already got the price you want, and you can start collecting dividends and option premiums. If then option is called and you 'lose' the stock - although you've 'missed' additional upside, you've still made money - repeat all steps, including step 6 below.
6 - If the current price is above the 50/200 day zone, look for a strike price within that zone, and pick an option exercise date that has reasonable volume (you can see all of that on Yahoo Quote on the symbol, and then Options). Sell the put, pocket the cash, and see if the price drops into the 50/200 day zone and you get the stock. If it doesn't, then do all the stpe over again - you're only missing the upside of something you don't own.

If somehow this is your primary investment strategy, you are probably better off doing it through a buy/write ETF or closed end mutual fund and not on your own....

Mike Griffin

September 23rd, 2010 at 5:08pm

Here's how a short-put works: you sell the put (thus getting the put-price x 100). You either keep the put until expiration, or you buy the same put (at whatever the current put-price is) to "close" your position. If you close then your profit (or loss) is the difference between the sold put-price and the current put-price (put-price is another way of saying "premium").
If it looks like the stock-price will remain above the strike-price then you should probably hold the short position until expiration, because the put will probably expire worthless and you will be able to keep the "premium" you got for selling the put in the first place.
If it looks like the stock-price will drop below the strike price at any time before expiration, (because of expected bad news, bad earnings report, etc.) then you should close your short position as soon as possible. Got it?
PS-being long a put is the opposite of being short, (i.e. you buy the put instead of selling it).

Peter

August 11th, 2010 at 6:04pm

It is only worthless if the underlying is trading above the strike price at the expiration date.

If the underlying is trading below the strike price at the expiration of the option then the option is worth the strike price minus the underlying price, which is your loss if you are short the option.

Emmanuel Armah

August 11th, 2010 at 10:29am

I don't understand why we use unlimited loss,
because you know your losses right from day one that the maximum loss is when the option expires the option becomes worthless.

am i right ?

Mjasko

April 16th, 2009 at 12:52pm

All of these comments deal with short term loses or gains. For me the question is whether the stock or company in question is a good buy at some price. If you believe that Goodyear is a good buy in any case at 15 and the stock is 20 who is really worried if Goodyear goes to 5 in the short term. All my equities have loss value lost value in the past year. Do I like it? No. But I am not in the market short term. Do I expect the market to go to zero. If it does then I have a lot more to worry about than the lost of a few dollars. Goodyear at zero is absurd...so why all the talk of unlimited loss...If you are so worried about loss stay out of the market. If you are long-term bullish then selling puts makes sense

Admin

February 15th, 2009 at 2:23am

You aren't anticipating the stock to drop...you are anticipating it to rally. If the stock is above the strike at expiration you keep the premium.

SGL#

February 15th, 2009 at 1:33am

How is a short put considered bullish if you are anticipating the stock to drop?

Admin

December 18th, 2008 at 6:22pm

Yep, noted. I mentioned it below too:

"I guess it is not really unlimited as a stock price cannot go below 0."

Rick

December 18th, 2008 at 1:13pm

"Maximum Loss: Unlimited in a falling market.", not really , how far can AAPL fall , cant go beyond 0 (zero)

Admin

December 8th, 2008 at 3:15am

Hi Marlowe,

Not sure what you mean. Are you saying that your broker won't allow you to sell a put option?

Marlowe

November 27th, 2008 at 10:29am

I would like to carry out the AAPL trade for real, however I am told I can not carry naked put. But, I can buy a call which will cover me. What are the suggestions for this? Happy to own the stock.

Admin

November 7th, 2008 at 7:10pm

I think the max loss on a short put is [(stock - strike) + premium] and seeing as the stock price is unknown and can therefore be anything it is reasonable to say unlimited.

john

October 31st, 2008 at 9:03am

yes i agree the max loss is [(Strike-Premium) - 0]. There can be large losses if the strike is large, but there is certainly limited downside.

Admin

September 23rd, 2008 at 10:27pm

A short put means that you are obligated to buy the underlying at the strike price if the buyer decides to exercise. So the payoff is the stock price minus the strike price less the premium received.

Once the underlying stock trades below the strike price price the option becomes out of the money. The option will continue to lose money as the stock continues a downward price movement.

I guess it is not really unlimited as a stock price cannot go below 0.

chris

September 23rd, 2008 at 2:01pm

Isn't the maximum loss for a short put the Strike price, not unlimited? This is not including the premium made on the sell of the put. So the net loss would be the Strike price minus premium

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