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Writing Call Options

When you buy a call option, you (as a holder) have the right to exercise the option at any time prior to its expiration by buying a number of shares of the underlying stock (depending on the number of contracts) at strike price. But you can also sell a call option in two ways. First, if you already hold call options you can sell them and thereby offset your long position. Second, you can actually issue (write) them and sell them to the buyers. In the first case since you offset your long position by selling the call options, your are squared away and have no obligation to the buyer. But in the second case, the net effect on your account would be a short position and that comes with certain obligations the most important being that you will agree to sell a certain number of shares of the underlying stock (based on the contracts sold) to the option holder at strike price prior to the option's expiration if the holder chooses to exercise his contracts. Remember that you do not know who the actual holder of your options is. All options are pooled at the OCC and traded at options exchanges. The buyer and seller never come in contact with each other.

Let's get back to our FAJ contracts. If you write 2 FAJ contracts at $2 premium, you will receive $400 (excluding commission) from the buyer. This also means that you are obligated to sell 200 shares of Ford to the holder at $50 per share prior to the expiration date if the holder chooses to exercise. And it is exactly for this right that you ask for the $2 premium. Three scenarios could now take place:

• You could end your obligation by buying 2 FAJ contracts at any time prior to expiration to offset the 2 contracts you wrote. In other words go long to offset your short position. Depending on circumstances you may have to pay more or less for the FAJ contracts than what you sold them for. For example, if Ford's …