One of the less risky option strategies is called “covered call
writing.” For example, you own a stock that has increased in price but you
don’t want to sell it because of the capital gains tax or some other reason.
However, you also think the market may be going down and it could affect the
stock price. So, you sell a call option against your stock and receive a
premium for that option. If the stock does go down, then the option will
probably expire worthless and you keep the premium. However, if the stock goes
up in price, you may have to sell the stock if the buyer of the call option
exercises his right. Before that happens, you can buy back the option and keep
your stock, so your only cost was the difference in the initial premium
received and the amount you had to pay to buy back the option.
Now let’s say you sell a naked call option on XYZ stock when the
price of the stock is Rs100 but you think the price is going down. Someone
bought that option from you because they thought the price was going up. So,
before the option expires, the stock moves to Rs120. Now the buyer uses his
call option to buy the stock from you at Rs100. You then have to go into the
market and buy it for Rs120 and sell it to him for Rs100. You've lost money
obviously, but the stock could have moved much higher so the potential for loss
is unlimited. If you had owned the underlying stock and sold that option, you
could just deliver the stock to the buyer of the option as we discussed in the
covered call writing example above.
Trading options is not easy and should only be done under the
guidance of a professional who not only has the knowledge but also the
experience in this area.
