Option Writing – Unlimited risk and Limited profit potential
An option buyer has limited risk and unlimited profit potential, so if 1 lot of 8000 Nifty call was bought at Rs 130, the maximum loss on this trade is the Rs 9750 (Rs 130 x 75), and if Nifty went to 8300 the call would make a profit of Rs 22,500 (300*75).
An option writer has unlimited risk and limited profit potential.
When you write an option, say 1 lot of 8000 CE at Rs 130, Rs 9750 (Rs 130 x 75) which is the premium paid by the buyer is credited to your trading account and this Rs 130 on the premium is your maximum profit potential. After taking this trade if
- Nifty is 7900 on expiry, value of 8000 CE on expiry is 0, and Traders Profit is Rs 9750.
- Nifty is 8000 on expiry, value of 8000 CE on expiry is 0, and Traders Profit is Rs 9750.
- Nifty is 8050 on expiry, value of 8000 CE on expiry is 50, and Traders Profit is Rs 6000 ((130-50)*75)
- Nifty is 8130 on expiry, value of 8000 CE would be 130, and Trade will be closed in No Profit No Loss.
- Nifty is 8300 on expiry, Value of 8000 CE would be 300, Trader need to take Loss of Rs 12750 ((300-130)*75)
- Nifty is 8500 on expiry, Value of 8000 CE would be 500, Trader need to take Loss of Rs 27750 ((500-130)*75)
The above is just a small example, Again Trader need to know Option Geeks(Delta,Theta,Vega) able to predict the volatility and also work on time value. We will try to cover each of these in forthcoming articles.
Succeed by not failing
Option writing is a strategy that can seem easy. Don’t be fooled or become over confident. Putting the odds in your favor — which is what you are doing when writing options — does not protect from the spikes in volatility that often wipe out even experienced option writers. For beginning traders, the first step is to not fail. Avoiding mistakes will keep you in the game as you hone your option selling skills and learn the intricacies of the markets you trade. It will take you a long way toward becoming an effective option seller for years to come.