In this introduction to options trading strategies, George Fontanills explains in his book how to sell an option you don’t actually own as the first part of your trade.
Options trading strategies: Selling an option you don’t own.
Selling a stock call option as an opening transaction obligates you to sell a certain amount of stock at a set price (strike price) at any point through the option’s expiry due. From the time you sell it until expiration weekend, you are required to satisfy that obligation if a call option holder chooses to exercise their rights. If an when this happens it is referred to as being assigned the option. Typically your broker contacts you informing you of the assignment.
Assuming you’re assigned on a call option contract, one of two possibilities exist:
- You owned shares of the underlying stock in the account which are then sold at the strike price; this results in closing the stock position in your account
- You did not own shares of the underlying, but the shares are sold at the strike price creating a short stock position in your account
A covered sell is one of the more popular, but slightly advanced options trading strategies and is something that will come up often as you learn options trading in general.
Selling a call option when you own the underlying shares is referred to as a covered transaction because the stock is said to cover the short call position. If you don’t own the stock, the position is refried to as a naked call. Your risk associated with a naked call option is the same as your risk when you short stock – unlimited.
When selling a call option as an opening transaction without owning the stock, your risk is the same as holding a short stock position. Because a stock can technically keep rising, your risk is unlimited.
Selling a stock put option as an opening transaction obligates you to buy a certain amount of stock at a set price (strike price) at any point up through the option’s expiration date. From the time you sell the put until expiration weekend, you are required to satisfy the obligation if a put option holder chooses to exercise their rights.
If you want to learn more about option trading strategies from a professional trader, then it will interest you to know that this is an excerpt from George Fontanills’ book called Trading Options for Dummies, available on Amazon.com right here >