When premium income is collected

Discussion in 'Options' started by triggertrader, Mar 16, 2007.

  1. i have a question. if i sell a naked call and the market is in the money at option expiration do i lose the entire premium income in my account which i collected when sold the option plus having to pay every point per tick that it has moved above the strike price?
  2. You lose the exact difference between the ITM strike price you are short vs. what the underlying price actually is. Depending on how much premium you wrote in the first place, it could be some of it or it could be all of it and allot more.
  3. MTE


    If you like you can think in terms of two separate transactions/cash flows. The intial one is the premium you recieve and it is yours to keep. The second one is at expiration when you either don't have to do anything (the call expires OTM or ATM, with some exceptions) or pay the difference between the strike and spot if the call expires ITM (obviously there're some mechanical differences between cash- and physically settled contracts, but the idea is the same).

    So, essentially, your PnL depends on the net cashflow.
  4. so what you're saying is that for example if i sold a 1.11 coffee call option for $300 and the strike was hit before expiration and it is now in the money at let's say 1.12. i would have to pay the option buyer $375? (coffee $3.75 a point x100)
    now let us say that is has expired. so in this case would i keep the $300 i sold the option for and lose $75?
  5. you mentioned that the call expires ITM or OTM. dont options expire in ITM as well? i thought all options expire isnt that correct?
    you also mention an interesting point that options expire OTM OR ATM with some exceptions. when you say some exceptions are you referring to when the buyer doesnt elect to excercise the option?
    also in reference when you say the diffrence between the "strike and spot" of the call. when you say spot are you refering to the current underlying futures price of the option?
  6. Not sure about the specifics of coffee options, however most futures options are european exercise, which means they can only be exercised on expiration Friday. If the call expires in the money, and the buyer chooses to exercise (they will exercise if its in the money), then come Monday after expiration, you will be short a coffee contract, and they will be long the contract. You can avoid this by closing out the option before expiration.
  7. Really? Certainly meats, grains, and softs are not European exercise.

    In this particular case, Coffee is definitely American-style.

    triggertrader--you do not pay anyone until they exercise the option, but you will have to post margin.
  8. MTE


    Yes, all options do expire, I was referring to the specific example you provided.

    An ATM option may or may not be exercised so if you short an ATM option you do not know what your position would be, known as pin risk.

    Yes, spot means the price of the underlying futures, stock or whatever it may be.
  9. very interesting. however closing out the option i sold can be difficult since it is very close to expiration and very illiquid. it will be tough to find a buyer for it no?
    my other question is if i would be short a coffee futures contract why cant i just notify my broker to automatically and immediately offset the coffee short as soon as i become short and will experience little loss?
    i have another question. if the buyer excercises the option do i still keep the premium income collected?
  10. ahh so if they excercise the option i have to give away the premium income initially collected correct?
    i know about margin, however i was told when you sell options you get a break as aposed to the underlying futures contract margins. they call it SPAN margin and it is discounted. i would think this is another advantage to selling options.
    #10     Mar 19, 2007