In trading, there are buyers and sellers, and their expectations are opposite to each other. For put options, buyers expect a significant drop in the underlying asset's price, while sellers do not expect a drop, including scenarios such as small increases, large increases, and sideways fluctuations.
Investors who expect the underlying asset's price to remain stable or mildly bullish can choose to sell put options to receive the option premium.
Selling put options allows the seller to receive the option premium paid by the option buyer. The seller sells a put option contract to the buyer at a certain price, and the seller hopes that the underlying asset's price will not decrease at the option's expiration date. If the buyer does not exercise the option, the seller retains the option premium. However, if the underlying asset's price drops at expiration and the buyer exercises the option, the seller must pay the buyer the difference between the strike price and the underlying asset's price, resulting in a loss for the seller. Additionally, because selling put options has an obligation to execute the contract, the exchange requires the seller to provide collateral in the form of margin.
Unlike futures, where both buyers and sellers must provide margin, only option sellers have an obligation, so they are required to provide margin.
Suppose the current BTC price is $25,000, and we expect the price not to drop significantly. Therefore, we sell a near-month put option on BTC with a strike price of $22,000 and receive an option premium of $1,000.
If the BTC price drops to $20,000 at expiration, the option will incur a loss of $1,000, as follows:
1,000 (option premium) - 22,000 (strike price) + 20,000 (expiration price) = -1,000
|Expiration Price||Strike Price||Option Premium||Profit/Loss||Option Type|
The profit/loss table shows the profit/loss on the expiration date. In trading, some investors may choose to close the position early, making the profit and loss calculation simpler: the seller's profit or loss equals the opening option premium minus the closing option premium, representing the income from the option premium difference earned by selling and buying.
It should be noted that when the expiration price is higher than the strike price, the seller's profit from selling put options is limited to the option premium. This is why we say that the seller's profit is limited, but the risk is unlimited.
Since the risk is unlimited, why do investors choose to sell put options? We can think of option sellers as insurance companies. They cover the payout amount resulting from infrequent events by charging a stable premium. Option sellers also have a high winning rate; they will sell a put option when they judge the probability of the option being exercised is low. Additionally, since the option's time value continues to decay, option sellers have a higher winning rate.
4. Risks of Selling Put Options:
- Margin Risk
Margin is required as collateral for the seller to ensure that they can fulfill the option contract. When selling an option, the seller collects a premium but also needs to provide margin as collateral. If there is a significant price fluctuation in the underlying asset or if the price moves in the opposite direction to what was expected, the seller may be required to increase their margin. If the seller is unable to provide the additional margin, their position may be forcibly liquidated.
Large price fluctuations in the underlying asset or movements in the opposite direction of what was expected can lead to substantial losses for the seller.
- Liquidity Risk
Options traders, can choose market price or limit price to close positions, but there may be slippage due to insufficient market liquidity, which will affect the income of options transactions.
- Naked Selling Risk
Naked selling of options can be very risky for novice investors. It is recommended to learn more about option combination strategies and hedging short positions.
- Stop-loss First
As the profit of an option seller is limited while their losses are unlimited, it is essential for novice investors to be aware of the risks and use stop-loss as the most effective risk control method, which is also a prerequisite for profits. Specific stop-loss methods can include setting fixed prices, psychological prices, capital ratios, and technical indicators.
- Start with a small position
Position control is a necessary lesson for option sellers because selling an option requires providing sufficient collateral. Once the position is too large, even if the direction is judged correctly, a lack of collateral due to short-term market volatility may lead to forced liquidation.
- Follow the Trend
As the risk for option sellers is theoretically unlimited without effective hedging, it is crucial for option sellers to judge the market direction accurately. More information about protection and hedging strategies for option sellers can be learned through practical options strategies.
- Value Volatility
Successful option sellers are always able to capture overpriced options. The core factor in option pricing is implied volatility. After opening a position, option sellers should pay close attention to changes in implied volatility.
- Start with Selling OTM Options
Novice investors can consider starting with selling out-of-the-money options. Compared to at-the-money or in-the-money options, the likelihood of out-of-the-money options being exercised is lower, and this low probability is the advantage of the option seller.