Options (Beginner)
- Thread starter FortyTwo
- Start date
In this YouTube tutorial he gives an example of Shorting a PUT Option
Example: ATVI: The current share price of ATVI is $67. The 14 day $65 Put price is $1.75. He collects the $175 Premium. One week before expiration the share prices is $63.65 (lower than my Strike price) and the Short Put Premium price on that day is $382. If he closed (bought) on that day he makes a loss of $207 ($382 - $175 = -$207).
Why could he not just buy 100 shares at $63.25 cutting his loss to $0.0?
((6,500 – 6,325) + 175) = $0.0
Same YouTube tutorial he gives an example of Shorting a CALL Option
Shorting Call Option
Netflix: Stock Price $370. Short Strike Price $400 Option Premium is £1,700. One day before the Call close date Netflix shares are $440 ($40 above my Strike price). And the $400 call premium on this day is $62.50 (x 100) so (in this example) he buys that Call Option making a loss of $4,550 ($6,250 - $1,700 = $4,550).
Why could he not just buy 100 shares at $440 cutting his loss to $2,700?
((44,000 – 40,000) + 1,700) = $2,700
Shorting Call Option
Netflix: Stock Price $370. Short Strike Price $400 Option Premium is £1,700. One day before the Call close date Netflix shares are $440 ($40 above my Strike price). And the $400 call premium on this day is $62.50 (x 100) so (in this example) he buys that Call Option making a loss of $4,550 ($6,250 - $1,700 = $4,550).
Why could he not just buy 100 shares at $440 cutting his loss to $2,700?
((44,000 – 40,000) + 1,700) = $2,700
The option questions in this forum range from Beginner to Advance.
he would have to short 100 shares and what would happen if the stock then rallied to 67?
He can and a lot of traders do if they are really confident that the share price would rise again after this temporary drop. BUT the thing is what if that was the market top for the stock? What if after buying the stock, the price keeps dropping or keeps dropping for a very long time? Then he would've incurred potentially larger losses just for avoiding the $207 loss in option. Would it be worth it? He obviously thought it was not.
He can and actually in this case he would've been left with lot smaller losses you are right but in this case he would've been exposed to what is called the "assignment risk" which is the risk of not being assigned when covered (prepared for the assignment) and being assigned when not covered. Assignment of the option when you are short is not always guaranteed and is not in the option seller's control. You don't decide whether the option that you sold gets exercised and you actually get assigned or not when it's ITM. Only 33% of the options are ever exercised meaning the owner of the option actually wanted to buy/sell their underlying stock using their options and the option sellers whose option is still ITM and outstanding get picked by random whether they are assigned or not. As you can see it's a lot more profitable to just sell your options back when it's ITM so a large majority of the option holders would just close out their option positions.
So it is possible that option sellers who are still short and the options being ITM do not get assigned at all. There have been quite a few cases where option sellers have actually been lucked out and not get assigned meaning he gets to earn the entire premium without being short in the actual NetFlix shares. Then in this case, if he's actually bought the NetFlix shares to prepare for the assignment, then he would be stuck with the shares and if NetFlix keeps going down after he bought the shares, he would again be facing potentially large losses which the Youtuber obviously is not prepared to incur.
Now looking at another scenario where he's short and the option is ITM and decides to not to buy the stock and just to face the assignment. Then he would be in an even more dangerous situation. He would be short the stock when and if the option is exercised against him and if NetFlix ever goes up, then he would be potentially in a short squeeze and could be losing even more than what he's put in.
Bottom Line: When you are shorting the option that has physical delivery settlement, NEVER EVER NEVER EVER be stuck with the option even when it's OTM (there is a risk to that as well) unless you are prepared to really own the underlying like in a short put situation. This is what the Youtuber is trying to illustrate.
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