3 ms·

In principle you have the same problem if you’re selling naked put options

NoboruWataya 4y ago
I think you mean selling naked call options. If you're selling put options, you are selling someone else the right to force you to purchase shares from them at a given price. Which means that you are long the shares and also that your downside is limited by the strike price.
robocat 4y ago
The price of a stock can only go to zero, so the value of a put option is bounded. A put option at exercise price of $2 has a maximum value of $2 (ignoring discount rate, conditions, etcetera). There are corner cases because a stock going to zero has other implications (e.g. cannot actually trade in that stock) which can affect delivery. Matt Levine puts it nicely: “Betting on disaster is hard because, if you win, there has been a disaster, and you might not get paid.” and he writes about (under CDS heading[2]) some of the other costly risks of shorting, some of which might also apply to options. The value of a call option is unbounded. This link[1] has some good questions and answers about options, although it certainly isn’t complete (e.g. dividends are mentioned but voting rights are not). [1] https://www.blackwellpublishing.com/content/kolb5thedition/chapter_12_solution.pdf https://www.blackwellpublishing.com/content/kolb5thedition/c... [2] https://news.bloombergtax.com/tax-insights-and-commentary/matt-levines-money-stuff-leaving-russia-for-morals-or-money https://news.bloombergtax.com/tax-insights-and-commentary/ma...
nopassrecover 4y ago
Both sibling comments are completely correct, and support the parent comment (thanks!). I got myself mixed up and was misled by a Corporate Finance Institute quote (which incorrectly notes the loss is unlimited only to contradict itself): For the seller of a put option, things are reversed. Their potential profit is limited to the premium received for writing the put. Their potential loss is unlimited – equal to the amount by which the market price is below the option strike price, times the number of options sold.

I think you mean selling naked call options. If you're selling put options, you are selling someone else the right to force you to purchase shares from them at a given price. Which means that you are long the shares and also that your downside is limited by the strike price.

robocat 4y ago

The price of a stock can only go to zero, so the value of a put option is bounded. A put option at exercise price of $2 has a maximum value of $2 (ignoring discount rate, conditions, etcetera). There are corner cases because a stock going to zero has other implications (e.g. cannot actually trade in that stock) which can affect delivery. Matt Levine puts it nicely: “Betting on disaster is hard because, if you win, there has been a disaster, and you might not get paid.” and he writes about (under CDS heading[2]) some of the other costly risks of shorting, some of which might also apply to options. The value of a call option is unbounded. This link[1] has some good questions and answers about options, although it certainly isn’t complete (e.g. dividends are mentioned but voting rights are not). [1] https://www.blackwellpublishing.com/content/kolb5thedition/chapter_12_solution.pdf https://www.blackwellpublishing.com/content/kolb5thedition/c... [2] https://news.bloombergtax.com/tax-insights-and-commentary/matt-levines-money-stuff-leaving-russia-for-morals-or-money https://news.bloombergtax.com/tax-insights-and-commentary/ma...

nopassrecover 4y ago

Both sibling comments are completely correct, and support the parent comment (thanks!). I got myself mixed up and was misled by a Corporate Finance Institute quote (which incorrectly notes the loss is unlimited only to contradict itself): For the seller of a put option, things are reversed. Their potential profit is limited to the premium received for writing the put. Their potential loss is unlimited – equal to the amount by which the market price is below the option strike price, times the number of options sold.