Understanding Equity Options - The Options Clearing Corporation

1) If the market price of the stock rises sharply,the calls could be assigned. To satisfy yourdelivery obligation, you may have to buy stockin the market for more than the option’s strikeprice. This could result in a substantial loss.2) The risk of writing uncovered calls is similar tothat of selling stock short, although as an optionwriter your risk is cushioned somewhat bythe amount of premium received.As an example, if you write an XYZ July 65 call fora premium of $6, you will receive $600 in premiumincome. If the stock price remains at or below $65,you may not be assigned on your option. Because youhave no stock position, the price decline has no effecton your $600 profit. On the other hand, if the stockprice subsequently climbs to $75 per share, you likelywill be assigned and will have to cover your positionat a net loss of $400 ($1,000 loss on covering the callassignment offset by $600 in premium income). As acall writer, your losses will continue to increase withsubsequent increases in the stock price.As with any option transaction, provided thatan exercise notice has not been assigned to his position,an uncovered call writer may cancel his obligationby executing a closing purchase transaction. Anuncovered call writer also can mitigate his risk at anytime during the life of the option by purchasing theunderlying shares of stock, thereby becoming acovered writer.Selling Equity PutsSelling a put obligates you to buy the underlyingshares of stock at the option’s strike price upon assignmentof an exercise notice. You are paid a premiumwhen the put is written to partially compensateyou for assuming this risk. As a put writer, you mustbe prepared to buy the underlying stock at any timeduring the life of the option.30