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Finding the underlying stock value of a call option?
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Finding the underlying stock value of a call option?

  #11 (permalink)
Market Wizard
Sarasota FL
 
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brags View Post
I have done a lot of tutorials and these are concepts that I am not quite clear on.
...
Quick question...if I purchase the option, and then exercise my right to buy... where do the shares come from?

At some point, someone wrote the option. (Created it by selling it.) That means they stood ready to have the stock called away if the option is exercised. They will either own the stock or have sufficient margin to go buy it if needed. What they expect is to put the price of the option in their pockets and so make a little extra income from the (usually unprofitable) call buyers.

On exercise, the exchange assigns the exercise to someone in the group of call writers.

Since you had that question, it would be a really good idea to follow the advice that I believe someone already gave, and go read a good, thorough book on options before going a step further. Getting these basic questions answered in this forum (and apparently in those tutorials you took) probably will mean you still have big gaps in understanding. It is not a simple topic.

Good luck with it.

Bob.

Edit: I just noticed that @choke35 really answered this part of the question:


choke35 View Post
Most options are never exercised; if they do, the shares normally come from covered positions, i.e. stocks that
are owned by institutions that increase their returns by writing options.

You might ask yourself, "Why would institutions believe that they can increase their returns, when they are risking having their stock called away?" Answer: they are right a lot more often than the (usually naive) call buyers looking for a killing. It's a simple way for a big holder to make some nice additional income from a large portfolio. It's also a reason to be cautious about the options game -- they may know something here....


Last edited by bobwest; September 21st, 2015 at 10:11 AM.
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  #12 (permalink)
Trading Apprentice
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bobwest View Post
At some point, someone wrote the option. (Created it by selling it.) That means they stood ready to have the stock called away if the option is exercised. They will either own the stock or have sufficient margin to go buy it if needed. What they expect is to put the price of the option in their pockets and so make a little extra income from the (usually unprofitable) call buyers.

On exercise, the exchange assigns the exercise to someone in the group of call writers.

Since you had that question, it would be a really good idea to follow the advice that I believe someone already gave, and go read a good, thorough book on options before going a step further. Getting these basic questions answered in this forum (and apparently in those tutorials you took) probably will mean you still have big gaps in understanding. It is not a simple topic.

Options trading for dummies is on the way.
I've read everything about them on investopedia...I was not clear on the difference between "Buying" and "Writing" calls and puts nor their relationship to the terms "Buying to open", "Selling to close", "Selling to open", "Buying to close", "Covered", "Uncovered", "In the money", "Out of the money" etc. I wanted to understand these concepts fully before moving on to other aspects of options. It's like when I was learning php...it was more important to grasp the concept behind the code than the actual code itself.


bobwest View Post
You might ask yourself, "Why would institutions believe that they can increase their returns, when they are risking having their stock called away?" Answer: they are right a lot more often than the (usually naive) call buyers looking for a killing. It's a simple way for a big holder to make some nice additional income from a large portfolio. It's also a reason to be cautious about the options game -- they may know something here....

As they say..."Professionals sell options and amateurs buy them".



bobwest View Post
Good luck with it.

Bob.

Thanks.


Last edited by brags; September 21st, 2015 at 12:33 PM.
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  #13 (permalink)
Elite Member
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brags View Post
As they say..."Professionals sell options and amateurs buy them".

Afraid it is not quite as simple as that. Here is a link to a very excellent thread - https://futures.io/options-cfd-trading/12309-selling-options-futures.html. Even though a lot of caution was adivsed in the thread, notice that several of the followers suffered much larger drawdowns than they were comfortable with.

Option selling has the risk of blowup which you can mitigate by hedging with the underlying, but then your returns diminish drastically. The big market makers have big bankrolls and can still make decent money on narrower spreads which in turn makes it more difficult for smaller players to survive.

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  #14 (permalink)
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Professionals buy and sell options, it's a misnomer to think they only do one or the other.

Professionals sell them covered to generate income, professionals sell them cash covered to own the stock, professionals buy them to hedge their portfolio.

That phrase should be changed to "Professionals buy and sell options covered, amateurs sell them naked".

I've seen millions of dollars blow up because of naked selling. Selling options OTM or FOTM teaches and reinforces all the worst trading habits on the planet.

1. Sellers don't market time, they sell like clockwork once a week/month/whatever - a good trader should time their entries and be aware of macroeconomic and fundamental forces
2. The RR is a tiny limited reward with massive open ended risk - a good trader should have a low risk to high reward ratio
3. Sellers are rewarded for holding positions indiscriminately waiting for time value to melt - a good trader should cut a position if it isn't working
4. Losses balloon as the option comes into the money, this is the same as adding to a bad position - a good trader doesn't add to losers, they cut them
5. Sellers roll bad positions for almost no premium hoping it will come back - a good trader shouldn't take on a new position unless it's a good trade and has its own merit, there should be no hope involved
6. Sellers play in an illiquid market - good traders play in the most liquid market possible so they can get out when things go pear shaped. Have you tried finding a market maker to buy your options back from when markets are tanking? Good luck.

There is no hedge strategy for FOTM or OTM that will make the RR worth it - sooner or later a black swan will swim past and blow you out of the water. If it works for 3 years and suddenly stops working, it never worked in the first place - you were picking up pennies in front of a steam roller, you were just too greedy to see it. The more you skew your RR, the longer you can go without blowing up, and the more you think you're a genius until it stops working and you're broke.

I don't want to be negative on the main options selling threads, but I can bet you none of them will be around when a real market crash comes. This 10% correction is nothing.

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