What is shorting/writing/selling in Options trading?

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Most traders buy Call and Put options. They buy call when they expect the market to go up and buy Put when they expect the market to go down. However, there is another interesting trade which is risky and is done by few traders. It’s called shorting or writing or selling Options.

In Option writing/shorting/selling, you sell a Call or Put option hoping that its price will go down and be resulting in profits for you. With a majority of Options traders buying options and a significant part of those trades expiring worthless, the probability of loss or less profit is more. Now when a majority of traders are losing then who’s gaining. It's the traders on another side i.e. sellers.

The time value also works in the favor of sellers while it works against buyers. With each passing days, if the market doesn’t move or falls, he is gaining. We all know Premium= Intrinsic Value + Time Value. So, if the intrinsic value doesn’t move then the seller is at an advantage as each passing day reduces the price of the premium.

An Option buyer has the limited loss, unlimited risk potential whereas for a seller it is the unlimited loss or bigger profit. Let’s understand this with an example;

Nifty 50 Spot Price

6694

Nifty 50 Short Call Strike Price

6600

Lot Size

75

Premium Received Per Share

₹ 154

Break Even Point (Strike Price + Premium)

6754

Max Profit

₹154 X 75= ₹11.550

Max Loss

Unlimited


Now let’s see how the payoffs vary depending on the closing price of the Nifty 50 on expiration day.

NIFTY 50 Closing Price (CP)

Net Payoff (BEP-CP)*75, Max Profit= 4500

6400

11550

6500

11550

6600

11550

6700

4050

6754

0

6800

-3450

6900

-10950

 

The above table shows that while you will be making a bigger profit in selling Options but there is also a higher risk if the market moves against your trade.

The margins are significantly higher for Option shorting in comparison to buying Option. Also, the margin is marked to market which means you have to maintain margin depending on your loss every day.

 

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