Options trading risk profile

We went over the basics of puts and calls in our introduction to options. Now, we want to build on that and cover the option risk characteristics of a call and put. Let's cover the risk profile of a call first.

I believe examples in this section would be the best way to cover this topic. We are going to start with a LONG CALL example. Once the underlying security is above the strike price, the option will move penny for penny with the security. The reward for the call buyer can be unlimited as the security can go as high as it wants to. Let's now take a look at the option risk profile of an option writer. For the sake of clarity, the term "write" refers to shorting or selling an option.

Shorting an option brings added risk, especially if the seller is "naked". The term options option" refers to the idea that the seller of the stock does not own the underlying stock that may eventually end up being called away by the purchaser of the option. Just like the naked put optionselling naked calls is a risky proposition and should be done only after much experience since there is no limit to the option based risk.

The most risk use for selling a call is part of a common options strategy known as the covered call. We will cover this strategy in far more detail, but the short story is that covered calls limit your downside exposure and add that extra bit of insurance and cushion to your long position.

Puts allow the put buyers the ability to force the writer of the trading to buy the underlying stock at the strike price. You options be asking what the difference between selling a call and buying a put is.

They both limit your downside risk, right? Yes, but there are two key differences. Puts protect you against disastrous or rapid declines in a securities value; calls will only limit the downside up to the value of the premium you received for selling that call. The second key difference lies in the fact that selling a call results in trading net debit to your account balance while buying a put will result in a net credit, or a cash outlay. As the stock moves lower, the put buyer moves into a profit position, penny for penny.

Finally, let's take a look at the short put risk chart. When you write a put option, options go short, you are selling premium risk anticipation that the stock will move higher and therefore you will be able to eat the entire option premium. Alternatively, a potential buyer of a stock may want to get long a stock and will sell puts to do it. As the stock moves lower, the price of the put moves higher and this results in greater losses trading the writer of the put.

Study these charts carefully and commit them to memory. Once you master these basics, you will be able to more fully understand the options strategies that we will cover. 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Facebook Twitter LinkedIn Email. Option Risk Profile We went over the basics of trading and calls in our introduction to options. Long Call Risk Characteristics Let's cover the risk profile of a call first. Long Put Risk Characteristics Lets start with a new example for the put section: Short Put Risk Characteristics Finally, let's take a look at the short put risk chart.

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Understanding Options Leverage - #1 - Option Trading Mistakes