02 May 2008

Two Sides To An Options Contract

We’ve learned that an option is a contract, and we’ve learned what your rights are if you own an options contract. But there are two sides to every contract, right? So if you buy an option contract, somebody has to sell it to you.

The person selling an option contract can be any market participant, market makers, other traders, whoever. It can also be you. This is often called “writing” options and the option seller often referred to as the “writer”.

We’ve learned that the option buyer has the right to buy or sell, so what does that mean for the option writer? That logically translates into obligations for the writer.

Thus, if the buyer of a call option has the right to buy, then the writer of the call option has the obligation sell, if the call owner exercises his/her right. The full statement therefore, is that the call writer has the obligation to sell a certain amount of shares, if called, at a certain price, on or before a certain date.

This is where the term “call” comes from; the option buyer has the right to “call” shares away from the option writer.

Looking at the put side of the equation, if the buyer of a put option has the right to sell, then the writer of the put option has the obligation to buy, if the put owner exercises his/her right. The full statement therefore, is that the put writer has the obligation to buy a certain amount of shares, if put to, at a certain price, on or before a certain date.

This is where the term “put” comes from; the option buyer has the right to “put” shares to the option writer.

In a Nutshell:

  • The call option buyer has the right to buy.
  • The call option writer has the obligation to sell.
  • The put option buyer has the right to sell.
  • The put option writer has the obligation to buy.
Next - Basic Options Pricing

1 comment:

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