Writing an Option

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Writing an Option

Key takeaways
* Writing an option means selling an option contract and collecting a premium in exchange for obligating yourself to buy or sell the underlying asset at a specified strike price by the option’s expiration.
* Standard stock options are typically written in lots of 100 shares.
* Premium size depends on the underlying price, time to expiration, volatility and other factors.
* Benefits include immediate income, time decay working in the writer’s favor, and flexibility to close positions. Risks include potentially large or unlimited losses for uncovered (naked) positions.

What it means to write an option

When you write (sell) an option you create a contract that gives the buyer the right — but not the obligation — to buy (call) or sell (put) the underlying asset at a set strike price by a specified expiration date. In return for granting that right you receive a premium up front. If the buyer exercises the option, the writer must fulfill the contract terms (sell or buy the shares at the strike price).

How it works

  • You choose the underlying asset, option type (call or put), strike price, expiration date and contract size.
  • The buyer pays you a premium; you keep this premium regardless of future price action.
  • If the option expires out of the money (OTM), the buyer will not exercise and you keep the full premium.
  • You can close the written position at any time by buying the same option in the market, which removes the obligation.

Benefits of writing options

  • Immediate income: premium received when the contract is sold.
  • Potential to keep the full premium if the option expires OTM.
  • Time decay (theta): options lose value as expiration approaches, which can reduce the cost to buy back the option.
  • Flexibility: you can buy back the option to close the position before expiration.

Risks and important distinctions

  • Unlimited risk for naked calls: a writer who does not own the underlying (naked call) can face theoretically unlimited losses if the underlying price rises significantly.
  • Large losses for naked puts: writing puts exposes you to significant downside if the underlying drops sharply.
  • Covered positions reduce risk: selling a covered call (owning the underlying while selling a call) limits upside loss from assignment because gains in the underlying offset some of the call liability.
  • Assignment risk: option writers may be assigned any time the buyer exercises (common near and at expiration).

Examples

Naked call (potentially unlimited loss)
* Example: You write a call on Stock X with strike $200. If the stock jumps to $275 by expiration, you must sell at $200 and incur the difference minus the premium received. If you don’t own the shares, you may have to buy them at the market price to deliver, creating large losses.

Covered call (limited risk)
* Example: You own 100 shares trading at $375 and sell a $375 call for $17. You receive $1,700 in premium. If the stock remains around $375 and the option expires worthless, you keep the premium. If the stock rises to $450 and the buyer exercises, you sell your 100 shares at $375 — you forego some upside but your stock ownership offsets the call’s obligation.

Practical steps to write an option

  1. Select the underlying security and option type (call or put).
  2. Choose strike price and expiration aligned with your objective (income, hedge, or directional).
  3. Determine contract size (standard equity option = 100 shares per contract).
  4. Place a sell order for the option and collect the premium.
  5. Monitor the position and decide whether to:
  6. Let it expire (if OTM),
  7. Buy it back to close,
  8. Accept assignment and deliver/receive shares.
  9. Manage risk with position sizing, using covered structures, or hedging if necessary.

Conclusion

Writing options can generate income and exploit time decay, but it carries meaningful risk — especially for uncovered positions. Understand the obligations, use appropriate risk controls (such as covered calls or position limits), and match option selection to your market outlook and risk tolerance.