# Writing options



## rowdy (19 July 2005)

Howdy Fellow Investors and the like,

For the sake of accurate paper trading i am interested in learning how to write an option, (both call and put).

From what i understand i know roughly how to work out the premiums, for example: $20 thousand worth of $4 per share would get 10 cents premium average (approx), but i dont know how to work it out precisely. Thats one thing i was hoping someone could help me with, how to precisely work out what premium you will get on your written option (call/put). Can we actually make up our premium based on criteria? Whats the process followed in determining these figures?

The other key component in writing an option contract is the strike price, i understand that depending on the strike price and the length of the option contract it will affect your premium. So how do we work out a strike price that will give us maximum premium, minimum premium etc..? And do we get complete control on what strike price is written into the contract? Can we say strike price of 20.50 for a sale price of say 20.49 and for say 3 mths etc...Or do we have complete freedom to write options for say 1mth with a strike price of 30 on a sale price of 10. 

Knowing this information will allow me to be precise in my paper trading and this is very important i believe if im to be confident at writing options. Some people will say that a broker writes your options, and thats great but if anyone knows how to do it and is happy to share, would be much appreciatted.

Just one more thing, if the strike price is set below the sell price on a call option, or a strike price is set above the sale price of a put option. What happens with the premiums when you write out calls and puts in this manner? Do they change at all?

For example a strike price of 10.50 was reached from a sale price of 10. And i wrote the put option, do i get the increase in share value also in addition to the premium?

And if i write a call option at 9.5 from a sale price of 10 do i receive the .5 movement in addition to the premium?

Please refrain from using links in your replies and if you are able to reply directly to the questions & comments that will help. Elaborate a little if you must, but please keep it relevant.

Thank you,

Rod


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## dutchie (19 July 2005)

Rod it would pay you to start at the ASX site and read up on options. There is lots of information there that will set you straight.


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## RichKid (19 July 2005)

Hate to spoil the party but if you are recovering from a bad trading/investment experience Rowdy shouldn't you be tackling something simpler than writing options? Just my view as I thought buying options can be very risky and writing can be riskier. What do the more experienced people out there think?
Still, it's only paper trading I guess.


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## Bloveld (19 July 2005)

From what i understand i know roughly how to work out the premiums, for example: $20 thousand worth of $4 per share would get 10 cents premium average (approx), but i dont know how to work it out precisely. Thats one thing i was hoping someone could help me with, how to precisely work out what premium you will get on your written option (call/put). Can we actually make up our premium based on criteria? Whats the process followed in determining these figures?

A. Go to the ASX site and look at the closing price of the share and look at the closing price of the various options. An option is only worth what people are prepared to pay for it.

The other key component in writing an option contract is the strike price, i understand that depending on the strike price and the length of the option contract it will affect your premium. So how do we work out a strike price that will give us maximum premium, minimum premium etc..? 


A. Depends on what you want to achieve. Maybe you want to get exercised.
Out of the money options get less premium but less chance of being exercised. At the money options get more premium but more likely to be exercised. In the money options get the most premium but highly likely to get exercised.


And do we get complete control on what strike price is written into the contract? Can we say strike price of 20.50 for a sale price of say 20.49 and for say 3 mths etc...Or do we have complete freedom to write options for say 1mth with a strike price of 30 on a sale price of 10. 

A. You can try but nobody wants options that far out of the money.

Knowing this information will allow me to be precise in my paper trading and this is very important i believe if im to be confident at writing options. Some people will say that a broker writes your options, and thats great but if anyone knows how to do it and is happy to share, would be much appreciatted.

A. A broker is required.

Just one more thing, if the strike price is set below the sell price on a call option, or a strike price is set above the sale price of a put option. What happens with the premiums when you write out calls and puts in this manner? Do they change at all?

A. You get more premium the further into the money that the options are.

For example a strike price of 10.50 was reached from a sale price of 10. And i wrote the put option, do i get the increase in share value also in addition to the premium?

And if i write a call option at 9.5 from a sale price of 10 do i receive the .5 movement in addition to the premium?

A. No you only get the premium.

Steve


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## rowdy (30 July 2005)

Those answers were somewhat helpful. Just a couple of things that werent clear. 

How do brokers go about writing the option for you? Do they follow the figures on asx also? So they check through say company xyz options and look at the different call/put options and tell you which ones you can write based on that? Or do brokers follow some formula based on market data to come up with figures? 


Another thing that is intriguing is how to calculate the depreciation of a premium over time. The way i understand it, the premium at the beginning of a written option is banked regardless. But as the month progresses that value drops. And over say two mths it would drop to a point where if your option contract was for 2mths it would be worth far less and at the end of contract it would actually be worthless. I was wondering if anyone knows how to mathematically calculate this?

Also curious to know if there is a mathematical calculation involved in writing the option and how it is calculated? 


Thank you,

Might seem like much for paper trading but theres no point to doing something if youre not going to do it with precision & thoroughness.

Rod


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## rowdy (3 August 2005)

Going by the response to the last post in this thread am guessing that noone around here can answer those questions.

So have just one other thing that someone on here might know.

On asx there is a column on the price of a share option, called :Open interest
Meaning:
The number of contracts currently outstanding for a particular series.

Am i correct to believe this determines whether the option is available to trading? Does zero mean there arent any available for trading? And if the figure is on say 20 it means that there are 20 contracts up for trading?

Thank you,

Rod


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## wayneL (3 August 2005)

Rod,

There are plenty of people here that can answer your questions. The reason you've got no response could be:

1/These are questions that are aswered by any basic option book, but, would require some effort to type out here. Solution - read a few books.

2/If you don't already know these answers, you shouldn't be considering written options. Perhaps people don't want to be complicit in adding to your previous woes.

Cheers


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## money tree (4 August 2005)

thanks wayne, thats exactly what I wanted to say

well actually I wanted to say:

"your questions are so green they are irritating"  : 

Im quite certain that between wayne, rembrandt, synapse and myself, any option question that can be answered will be.


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## tech/a (4 August 2005)

money tree said:
			
		

> thanks wayne, thats exactly what I wanted to say
> 
> well actually I wanted to say:
> 
> ...




*Why do you have to be so obnoxiously pretentious----------Wayne said it all no need for you to jump in and rip the guys throat out!!!!!*

Welcome to the forum by the way Rowdy!

Go buy 'The New options advantage" by Caplan---think there is a new edition.


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## money tree (4 August 2005)

look out, he's blown another fuse!!

"Why do you have to be so obnoxiously pretentious..."

hahaha thats rich. how was what I said even remotely pretentious, oh humble one? In fact I complemented 3 members of this forum. 

"...no need for you to jump in and rip the guys throat out!!!!!"

hilarious. hypocracy at its best. The master of dummy spits lectures me. Rip his throat out eh? Geez, slight exaggeration there....

you find something to whine about regardless of what I say.


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## RLN (4 August 2005)

rowdy, 
Option premium is made up of several variables all of which will change based on the movements of the underlying price, time and expectations. You need to thoroughly understand all these variables and what impact they will have, especially so if you intend to write naked options. *Naked options have unlimited risk*.

An option that has a lot of time available till expiry will have a higher premium value because time is money in the world of options. Options are a decaying asset, so one that has further to run will have a greater amount of time value built into them. But remember, the more time available means the higher the chance that the option will move one way or another.

The possibility of that movement is known as delta. Delta is a number between 0 and 1 or in easy terms think of delta as a % probability of the option moving into the money. So, if you have a delta of 0.5 then you have a 50% chance that the option will expire in the money. If you look carefully you will see that at-the-money options will have a delta of 0.5 and deep-out-of-money (OTM) will have a delta approaching 0.0. Chances are that a deep OTM will expire worthless. The less the delta then the less the premium will become.

Next is volatility and I have stressed elsewhere that volatility is a core input into pricing models. An option with a high volatility has high expectations of movement and therefore will have a higher premium attached to it. If volatility is low the option premium will be lower. Many professional traders just trade volatility on its own.

I strongly suggest Sheldon Natenberg's "Option Pricing and Volatility". It's an easy read on a complex subject but you'll not need to look elsewhere.


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## rowdy (5 August 2005)

Wow,

Thank you for all the responses,

Yes you are all correct in what you say about me, i need to acquire the knowledge that books offer, i need to understand the information found in different sources etc...

Have to admit that the reason i find myself asking so many questions is because i struggle to understand all the literature stuff and when a question pops into my head, i have noone to ask it. Thats why i thought i could ask here. When searching for answers in books that dont have the answers to the questions asked, its quite a futile activity.

 If i could just share one other thing that i love the least, is people who answer questions with stuff that seems to go off track completely, all it does is give the impression that they are too concerned with their own shiit and cant be bothered really helping you, but they say that they love to help and really they dont. Just had to share that didnt i? :headshake

But i understand that options already derivatives are quite complex.

Ideally i would go to someone who was a tutor and they might be able to teach me, but not just teach me how options work, but teach me ways in which to invest using options to create wealth and manage risk.

But thats me in dream land. Options tutor :biglaugh; maybe a mentor someone who would love a student and wouldnt expect $ in their pocket :bananasmi hahaha is there actually anyone out there that actually makes an excellent living on options and has tonnes of time to spare to enjoy life? And has so much wealth and time to spare that can pass on their knowledge without wanting more $. hehe now look whos losing it, off in dream land again. But you know just expressing myself.

I have grasped some simple principles, but sometimes it just gets so complex that unless i can be clear on the questions that pop up, i wont get involved in options until its all crystal clear. Cause right now this is what happens to me just when i think i have understood something  

If i cant simulate a paper trade correctly, theres no point actually investing, so all i want is the knowledge of all factors involved in the activity so that nothing is a surprise and i am prepared for all situations.

School wasnt the education for me, and now i get advised to read more books as if at school again. When working in the Engineering & Manufacturing Industry the school program was decent, we would read some instructions, and then simulate the instructions and put the theory to practice, surely theres a way to do this with options. And surely just like a Quality assurance department you can learn how a finished product will turn out and whether its good enough to provide to the customer. Or in the case of options learn whether a strategy is well honed enough to put into real practice.

Well ill stick at it, patience and inner peace will be my guide.

Who in the world came up with all these options etc...and why..


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## wayneL (5 August 2005)

rowdy said:
			
		

> right now this is what happens to me just when i think i have understood something




It's all part of the process Rod. You can expect that for a long time if you're normal LOL



			
				rowdy said:
			
		

> Who in the world came up with all these options etc...and why..




They were originally created for investors to hedge their portfolios.

Cheers


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## mit (5 August 2005)

Rowdy,

I don't know if an option book would help. I think you need to ask why are you going straight trading options when you are a beginner? And why you want to go straight to writing options?  If you want leverage why not go to CFDs or Margin Loans. With options shares can move in the correct direction but you make a loss because of volatility changes.  

Also the problem with writing options is that you tend to make many small wins to each large loss. The temptation to overtrade your position after a number of winning trades would be high and would be a disaster. 

Also if you have already blown your account once (which is nothing to be ashamed of many have done so), you most probably more need to spend some time with something lower risk. Making sure that your money management and discipline is iron clad. With discipline and good MM you can still lose your money but it will take a long time. Gives you time to figure out what wrong and fix it.

Without these even with a winning system you can go broke very quickly. Alan Hull mentions in his book a study done on the 90% of traders and investors that fiail and by far the biggest reason for failure was overtrading. Getting greedy and taking a too big a risk.

MIT


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