When do you short sell an option?

[Naked shorts]

So im not a option trader (and dont really plan on becoming one), so bare with my lack of knowledge.

I have noticed on some different brokers that they allow you to sell an option. This means your potential profit it limited to the cost of the option, and your potential loss is effectively unlimited.

Why would they offer this functionality if no one would use it? One could easily just buy put option instead of selling a call (in which case your potential profit would be unlimited and your potential loss would only be the cost of the option).

Another point i noted when going through the PDS from Go Markets, is that they dont not recommend you sell an option unless you are a professional trader.

So when would someone sell option?

p.s. Is what im talking about called "short selling an option" or just "selling an option"?

 

[skyQuake]

You are hoping to earn the premium when you short sell an option (write the oppie)

Most retail option players are long delta. ie Low probability success, but high payoff.

The other side of the trade is to sell the option. High probability of success but low profit when it eventuates.

Right now volatility is very high, so thats priced into the options, making them more expensive (more premium)

- Its recommended for professionals etc because of the potentially huge losses, also you need to really understand the maths behind it to make it work for you.

 

[wayneL]

So im not a option trader (and dont really plan on becoming one), so bare with my lack of knowledge.

I have noticed on some different brokers that they allow you to sell an option. This means your potential profit it limited to the cost of the option, and your potential loss is effectively unlimited.

Why would they offer this functionality if no one would use it? One could easily just buy put option instead of selling a call (in which case your potential profit would be unlimited and your potential loss would only be the cost of the option).

Another point i noted when going through the PDS from Go Markets, is that they dont not recommend you sell an option unless you are a professional trader.

So when would someone sell option?

p.s. Is what im talking about called "short selling an option" or just "selling an option"?

In addition to skyquakes post:

The most common short option position is the covered call. That is selling a call option over shares you own. The idea is to collect the premium on a share that is not moving up strongly, or to partially hedge a downtrending share you don't want to sell.

If there are share you would like to own, but at a lower price, you can sell puts. If the price moves up or stays the same, you keep the premium. If the price moves down you get the shares at the strike price, plus keep the premium.

I've been doing a bit of this on shares I wouldn't mind acquiring. Premiums are so high at the moment, that I'm lowering my effective buy price quite markedly, just by selling puts and calls around a stock position. I end up with shares that at a very low cost base that I can tuck away for keeps.

Also there are a number of strategies that use short options as part of a spread. A bit more complicated to explain, but if you're around the option pages a bit, you'll catch on.

But the general principle of selling options, both on their own and as part of a spread, is trading volatility rather than direction. It's a higher probability of picking where share price won't go, rather than where it will go.

For instance, will Goldman Sachs get to $35 or lower before December 20? I'm betting that it doesn't and I've done this with a spread trade. Where it does end up, I couldn't give a toss, maximum profit is anything above $35.

 

[Naked shorts]

it makes sense now! much appreciated

 

[sails]

Hey Wayne, good to have you helping out with the option questions again - welcome back .