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.
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Finance: What Is a Call Option?25 Views
finance a la shmoop. what is a call option? option? option, where are you? okay
yeah yeah. not phone options, call options. and a close but no cigar. a call option [man smokes in a tub of cash]
is the right to call or buy a security. the concept is easy the math is hard.
you think Coca Cola's poised for a breakout as they go into the new low
calorie beverage business. their stock is at 50 bucks a share and you can buy a [man stands on a stage as crowd cheers]
call option for $1. well that call option buys you the right
to then buy coke stock at 55 bucks a share anytime you want in the next
hundred and 20 days. so let's say Coke announces its new sugarless drink flavor
zero it's two weeks later and the stock skyrockets to fifty eight dollars a
share. you've already paid the dollar for the option now you have to exercise it. [man lifts weights]
so you buy the stock and you're all in now for fifty five dollars plus one or
fifty six bucks a share and your total value is now fifty eight bucks. well you
could turn around today and sell the bundle that moment, and you'll have
turned your dollar into two dollars of profit really fast. and obviously had the [equation on screen]
stock not skyrocketed so quickly well you would have lost everything. still you
lucked out and now you're sitting on some serious cash, courtesy of your call [two men in a tub of cash]
options. as for Coke flavor zero turned out to be nothing more than canned water.
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