Option Writer: Overview of Long and Short Strategies

What is an option writer?

An option writer (or grantor) is the seller of an option contract. The writer receives an upfront premium from the buyer in exchange for granting the buyer the right — but not the obligation — to buy (call) or sell (put) the underlying security at a specified strike price before expiration.

Writers can be:
* Covered — the writer holds an offsetting position (e.g., owns the underlying when selling a call, or is short the underlying when selling a put).
* Uncovered (naked) — the writer has no offsetting position and therefore faces significantly greater risk if the market moves against them.

Key takeaways

• Writers collect premiums and aim for contracts to expire worthless (out-of-the-money).
• Covered writing is generally conservative; uncovered writing can expose the seller to large or unlimited losses.
• Time value (theta) benefits writers because option premiums typically decay as expiration approaches.

How option writing works

When you sell an option you:
* Receive the premium immediately.
* Take on the obligation to deliver (if a call is exercised) or purchase (if a put is exercised) the underlying at the strike price if the buyer chooses to exercise.

If the option stays out-of-the-money until expiration, the writer keeps the entire premium. If it finishes in-the-money, the writer may face losses equal to the difference between the market price and the strike (offset by the premium received) or must buy back the option at a higher price to close the position.

Covered vs. uncovered risk

• Covered positions limit exposure. Example: selling a call while owning the underlying stock lets you deliver shares if exercised, capping losses to the stock’s downside plus forgone upside.
• Uncovered (naked) positions can create large losses. Example: selling a naked call when the stock surges forces you to buy shares at market price to deliver at the strike, potentially producing unlimited losses as the stock rises.

Call writing

Covered call strategy:
* Often used to generate income, commonly on dividend-paying or stable stocks.
* Possible outcomes:
– Option expires worthless: writer keeps premium.
– Option finishes in-the-money: writer can let shares be called away (sell at the strike) or buy back the option to close; profit/loss equals premium received minus any cost to close or opportunity cost of capped upside.
* Downside: if the stock falls, premium cushions losses but does not eliminate them.

Uncovered call:
* If exercised when the stock is above the strike, the writer must acquire shares at market price to meet delivery or close the position, potentially incurring large losses.

Put writing

Covered put:
* Covered if the writer is short the underlying; the short position offsets assignment obligations.
Uncovered put:
* If exercised and the writer does not have a short position, they must buy shares at the strike price or buy back the option, which can produce losses if the market price is much lower than the strike.

Time value and premium decay

• Premium = intrinsic value + time value.
• Time value reflects the chance the option will move in-the-money before expiration.
• As expiration approaches, time value decays (theta), benefiting the option writer — an out-of-the-money option that retains only time value will decline toward zero if the underlying doesn’t move into-the-money.

Example: writing a call on stock

Assume stock trades at $210. You sell a two-month $220 call for $3.50 (premium = $350 per contract).
* If the stock stays below $220 at expiration — you keep the $350.
* If the stock rises to $230 and you sold the call uncovered:
– You’d have to buy shares at $230 to sell at $220, losing $10 per share, offset by the $3.50 premium (net loss $6.50 per share or $650 per contract).
* If the call was covered (you owned the 100 shares bought at $210):
– Your shares would be called away at $220: you’d keep the $350 premium and realize a $1,000 gain on the stock, but you would miss further upside above $220.

Practical considerations and risk management

• Selling options is primarily an income strategy; keep in mind the trade-off between income and potential obligation.
• Use covered strategies if you want to limit downside and avoid unlimited risk.
• Monitor expirations and be aware of events (earnings, dividends, buyout rumors) that can cause abrupt price moves.
• Manage margin requirements and have a plan to close or hedge positions if the market moves against you.

Conclusion

Option writing can generate steady income through premium collection, but the level of risk depends greatly on whether positions are covered or uncovered. Covered writing is more conservative and suitable for many income-focused traders; naked writing requires robust risk controls because losses can be large or theoretically unlimited. Understanding time decay and position management is essential for successful option writing.