Option Writing – Unlimited risk and Limited profit potential

By | November 28, 2015 11:00 am
17 Comments

In Continuation with Previous Article Mistakes to avoid when writing/shorting Options

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

  1. Nifty is 7900 on expiry, value of 8000 CE on expiry is 0, and Traders Profit is Rs 9750.
  2. Nifty is 8000 on expiry, value of 8000 CE on expiry is 0, and Traders Profit is Rs 9750.
  3. Nifty is 8050 on expiry, value of 8000 CE on expiry is 50, and Traders Profit is Rs 6000 ((130-50)*75)
  4. Nifty is 8130 on expiry, value of 8000 CE would be 130, and Trade will be closed in No Profit No Loss.
  5. Nifty is 8300 on expiry, Value of 8000 CE would be 300, Trader need to take Loss of Rs 12750 ((300-130)*75)
  6. 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.

17 thoughts on “Option Writing – Unlimited risk and Limited profit potential”

  2. jamwalr

    Selling OTM calls with delta between 0.8-0.1 makes sense. Near expiry slightly OTM calls with delta around 0.3 also makes sense..I avoid naked put writing….Prefer strangles shorting one day before any event to capture enhanced volatility(Vega).

    But OPTIONS are still the safest and greatest way of making consistent wealth…My probabality of sucess is 2/3 from day one unlike option buying where the probability is just 1/3

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  3. Nat El

    Assuming a trader knows technical reading, then the only reason why he/she fails is GREED. “Discipline” is too mild a term to express your state of mind when trading in stocks. Over confidence soon overtakes after a couple of winning trades. Traders would have to remember AT ALL TIMES while trading…..Market will take back what it may have given you; even your capital!

    As Aditya has written, one needs to learn from mistakes.
    regards to all

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    2. PRAKASH TANAK

      When you sell 8000CE @ 130 your BEP is 8130 Since you have sold CE, it means that you are bearish in view and you will gain when NIFTY expires below 8130 So when NIFTY expires at 8000, you gain 130*75=9750 and when it expires at 8300 you lose 170*75=12750 Gain in case of sale of any option is always restricted to the anount of premium collected by you. Hope I am clear.

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    1. PRAKASH TANAK

      Since premium is made up of Intrinsic value & time value, as the price of underlying security increases premium also increases. But as the days go by and expiry comes near, the time value decreases. This decrease in time value is not uniform every day and its velocity of decrease increases as the expiry comes near. As long as the increase in Intrinsic value is more than the decrease in time value, premium increases. When it is other way, premium goes down. It is said that after 15 days of the contract period (not 15th of every month) that time value starts declining rapidly. Hence one should not buy an option when expiry is near, at the most one can sell option during such time. Let us wait for Bramesh Sir to give us a deeper knowledge on The Greeks to understand how various factors affect the premium. Bramesh Sirjee, I am eagerly awaiting your article on The Greeks.

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  7. Ajay

    ajay..no one will give 100% correct calls.. the problem is we trade with out analysing ..we depend on advisers ..its our problem..and main thing ppl who wanna make quick bucks will lose capital but nothing …stock markets will give money if u have enough money to trade and have patience and disciplined trading..its waste of time scolding advisers and concentrating on our own methods..if you r an investor go with fundamentals buy on lows and wait till it gives good profit..if u r trader go with trend and trade nifty100 scrips so u can gain easily …

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  8. Ajay

    Dear Sir,
    There are many advisory service providers in the market offering 99% accurate calls.Last Year I subscribed one scheme which helped me to wipe out all capital and through me out of the market for nearly 3 months.Now a days I follow only some good blogs which helped me to prevent my capital and give some reasonable profit.
    The main problem with the advisory service is that the market is turn out there 99% into a mere 1`%.This is written in this blog for the people to prevent from being a pray of so called advisory Gurus.

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    1. Aditya

      Problem when you don’t learn from mistake but if you correct yourself after every mistake then no one can stop you to become successful….keep learning ….Best of luck dear

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