| |
Writing (selling short) a Put option without the money needed to buy the underlying security. Strategy forecast for the financial instrument is neutral to bullish in the short-term also it would lose value through time decay, and eventually if the contract not assigned, at expiration will be worthless (out-of-the-money). Before entering a trade, please check the account requirement and restrictions (see the following note).
Prospect Direction: the stock will be neutral or even bullish, considering the duration advantage and implied volatility disadvantage (if the financial instrument will decline normally IV will increase).
Profit Potential: at expiration, the premium.
Loss potential: financial instrument price could decline to zero and not below, then there is a low boundary to the losses.
Risk reward: premium received, divided by probable loss.
Breakeven points: at expiration, strike - premium =stock price.
Time factor: All other variables stay unchanged, an option typically loses time value premium with every passing day, and the rate of time value loses tends to accelerate as it reaches to the end of its term, the expiration date. As with most short option strategies, the passage of time has a positive impact to the short seller. As time remaining to expiration decreases the statistical chances for a loss in intrinsic value shrinks, too.
Implied volatility: An increase in implied volatility would affect a nega-tively on this strategy, all other variables being equal. Volatility tends to boost the value of any options, because it indicates a greater statistical probability that the stock will move enough to give the option intrinsic value by the expiration day. On the other hand, a decline in volatility has a tendency to lower options value, regardless of the overall stock price trend.
Dividends: dividend affects negatively on Put option contract short seller (writers). On an ex-dividend date, the amount of the dividend will deduct from the value of the underlying stock. Although the effect is foreseeable and usually factored more gradually, dividend dates are still a consideration in deciding when it might be optimal to write a Put position.
Assignment: There is a chance that the option contract holder will assign his contract before expiration because option contract holder has, up until the expiration day the right to assign his in the money contract, else, the contract will settle with cash.
Assignment, Sometimes, in favor of the contract writer and the reason is that pre concession of contracts holder on the remaining time value to expiration. On the other hand, sometimes assignment is not in favor be-cause of its dependency on fees and slippage.
Assignment process, as the assignment notice arrives to the clearinghouse, settlement price sets on the assignment day's closing price, at this price, the contract writer will buy the underlying security then the clearinghouse will position the writer by the same amount and price, long underlying securities.
The next day the writer will be in a long underlying position and the contracts owner will be in short position.
Marked to Market profit and loss:
Let us assume assignment of 10 contracts at strike 45 and underlying security at price of $43.
Contract owners account after the assignment:
'10X100X45' (100 deltas or number of stocks for every contract).
Short position assignment price is $45,000.
Current position market price is $43,000.
Marked to Market profit and loss is: $2000 profit.
If prior to the assignment the account was long 1,000 underlying securities, then the account will be with no stock and remaining cash of $2000, else, the account position is short 1,000 underlying securities.
If the contract holder does not wish to be in the short, position or does not have sufficient margin funds, then the contract owner must buy the underlying securities back in the market.
At this point, the contract owner exposed to market price fluctuations.
Contract writer account after the assignment:
'10X100X45' (100 deltas or number of stocks for every contract).
Long position assignment price is $45,000.
Current position market price is $43,000.
Marked to Market profit and loss is: $2000 loss.
If prior to the assignment the account was short 1,000 underlying se-curities, then the account will be with no stock and short cash of $2000, else, the account position is long 1,000 underlying securities.
If the contract holder does not wish to be in the long, position or does not have sufficient margin funds, then the contract owner must sell the underlying securities back in the market.
At this point, the contract writer exposed to market price fluctuations.
Note:
Writing (selling short) a Put option requires an authorized margin account with the following restrictions; account net worth should be more than $100K, proper amount of money to cover probable incurred losses.
A common brokerage firm calculates short selling risks according to the financial instrument probable volatility called standardized stress of the underlying. For instance, equity options, narrow based indices, single stock futures, and mutual funds the stress parameter is plus 15%, minus 15% and add the premium received. To illustrate a short Put required funds let's take for an example, writing one Put, strike 50, stock price at 48, 45 days to expiration.
Calculation will be as follows, the risk is on the downside, 52X0.85= 40.8
Then 50-40.8=9.2 premium received 3.1, means the account must have funds exceeding 9.2+3.1=12. 3 for every contract (more than three times the premium), Broker monitors margin requirements in Real time and will liquidate the account 10 minutes after the margin call, if there is no response fixing the margin requirements .
Examples:
In the following examples, we will examine writing Put alternatives. You will understand that even if it seems simple to short a Put option, you need to explore all alternatives and pick the right contract.
Further, you will see which contract better fits your outlook. It all comes to a proper plan of your way to success.
Short 'ITM', 'ATM', 'OTM' Put Option Contract:
'ITM', in the money, Put option contracts premium is usually higher be-cause of its intrinsic value, it devaluates less from time decay and less sensitive to a change in the implied volatility. On the other hand, the short Put option contract will relatively be riskier to a decline in the underlying security standpoint. If the strategy outlook is very bullish, then you can write this contract.
'ATM', at the money Put option contract devaluates more from the time decay and revaluates more from a change in the implied volatility. Put option contract benefits even from a moderate gain in the underlying asset value. If the strategy outlook is neutral to bullish, then you can write this contract.
'OTM', out of the money, Put option contract devaluates the most from time decay and less from a change in the implied volatility. Put option contract benefits the most from a slightly bearish to neutral and of course bullish.
|
|
Fundamentals 
