Overwrite

  

Categories: Derivatives

There are two sides to every option contract. Someone buys it. Someone sells it. The person who buys the option pays the seller to get it. Put that another way, the seller receives money (called a premium) when the option contract is written.

Overwriting is a strategy to collect these premiums. The writer of the options contract either puts the strike price very high or very low, with the expectation that the underlying asset won’t reach that level. They expect the contract to expire on exercised.

You sell a call option for shares of BAC at $40 a share, with an expiration a month from now. You get $1.50 for selling the contract. The stock is currently trading at $25. You think its very unlikely that the stock will rise 60% by the expiration date. You're technically on the hook to deliver those 100 shares of BAC if the option gets exercised. But you think that's likely not going to happen. Most likely, shares won't get anywhere near $40 and the option will expire unused. And you get to pocket the $1.50.

Related or Semi-related Video

Finance: What are stock options in 90 se...0 Views

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Finance allah shmoop what are stock options in ninety seconds

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or less Here's a stock ibm not the tech company

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This one makes an anti constipation drug It's trading at

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one hundred eighty bucks a share Okay so here's an

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option of buy a share of ibm anytime in roughly

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the next three months For one hundred ninety dollars a

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share it's called a call option If you really believe

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the ibm will go to say two hundred dollars a

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share in the next three months well you'd be what's

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called ten dollars in the money then or then have

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a stock option or call option with a strike price

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of one hundred ninety dollars which would then have intrinsic

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value of ten bucks a share On the other end

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of the buy sell desk is the gal willing to

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sell you that call option for three bucks Three bucks

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a premium So gut check time Would you pay three

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dollars for the right to buy a share if ibm

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for ten dollars higher than where the stock's trading now

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today Meaning that to break even in the next three

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months the stock has to trade all the way up

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from one hundred eighty dollars a share to one hundred

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ninety three dollars a share jobs for you to get

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your money back but it goes to two hundred two

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share Well if you sell that option you'll have invested

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three bucks a share for a net return of seven

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bucks in just three months or less And yes we're

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ignoring commissions and taxes here because well in problems like

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this or just a in the book but three dollars

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into seven only three months Yeah that's a great score

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You'd have more than doubled your money And on an

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annualized return basis that's over a nine hundred percent dish

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return really good score but with a much more likely

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case that you spend three bucks to buy the option

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and it expires totally worthless And then you've lost your

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entire investment in that option So that's a call option

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It's evil twin is a put option So whereas a

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call options the rightto by a security to set price

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by a certain set date a put option is the

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right to sell that option We'd go into more detail

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here but we're promised ninety seconds

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