What is Call Writing and Put Writing? – Option Writing Strategies

Call writing and put writing are both option selling strategies in which traders sell option contracts with the expectation that they will expire worthless. Here are some key points about call writing and put writing:

What is Call Writing and Put Writing?

Call Writing:

1. Call writing involves selling call options to earn a premium, with the expectation that the underlying stock or index will remain below the strike price of the option.
2. If the option expires without being exercised, the seller keeps the premium as profit.
   However, if the option is exercised, the seller must sell the underlying stock or index at the strike price, which could result in a loss if the stock or index has risen above the strike price.
3. Call writing is often used as a way to generate income from stocks that the trader already owns,
   as the premium earned from selling the call options can offset any potential losses if the stock price falls.
4. Covered call writing is a popular call writing strategy in which the trader sells call options on a stock that they already own.

Put Writing:

1. Put writing involves selling put options to earn a premium, with the expectation that the underlying stock or index will remain above the strike price of the option.
2. If the option expires without being exercised, the seller keeps the premium as profit.
   However, if the option is exercised, the seller must buy the underlying stock or index at the strike price, which could result in a loss if the stock or index has fallen below the strike price.
3. Put writing is often used as a way to buy stocks at a discounted price, as the premium earned
   from selling the put options can reduce the effective purchase price of the stock.
4. Cash-secured put writing is a popular put writing strategy in which the trader sets aside cash
   to cover the potential purchase of the underlying stock or index if the option is exercised.
   This can limit the potential loss if the stock or index falls below the strike price.

Here are examples of call writing and put writing in India:

Call Writing Example

For example, suppose a trader believes that the stock of XYZ Ltd will remain range-bound
and not rise above a certain level.
The trader can sell a call option with a strike price higher than the current market price of XYZ Ltd stock. Let’s say the stock of XYZ Ltd is currently trading at Rs. 500 per share, and the trader decides to sell a call option with a strike price of Rs. 550 expiring in one month, earning a premium of Rs. 5 per share.

If the price of XYZ Ltd remains below Rs. 550 per share by the expiration date, the call option will expire worthless, and the trader keeps the Rs. 5 premium as profit.
However, if the stock price rises above Rs 550 per share, the call option may be exercised,
and the trader must sell their shares at the strike price of Rs 550 per share, potentially missing out on further gains.

Put Writing Example

Suppose a trader is interested in buying the stock of ABC Ltd and believes that the current market price of Rs 1000 per share is too high.
The trader can sell a put option with a strike price lower than the current market price of ABC Ltd stock. Let’s say the trader sells a put option with a strike price of Rs. 900 expiring in one month, earning a premium of Rs. 10 per share.

If the price of ABC Ltd remains above Rs. 900 per share by the expiration date, the put option will expire worthless, and the trader keeps the Rs. 10 premium as profit.
However, if the stock price falls below Rs 900 per share, the put option may be exercised, and the trader must buy the shares of
ABC Ltd at the strike price of Rs. 900 per share, potentially resulting in a net cost of Rs. 890 per share
(Rs. 900 strike price minus Rs. 10 premium earned).

Option Writing Strategies

Here are some best option writing strategies in India:

1. Covered Call Writing:
   A strategy where an investor holds a long position in a stock or security and simultaneously sells a call option on that same asset.
   In a word, this strategy allows the investor to earn premium income while also potentially profiting from an increase in the underlying stock’s price.
2. Cash-Secured Put Writing:
   A strategy where an investor sells a put option on a stock or security that they are willing to own, with the intention of buying it at a lower price if the option is exercised.
   The investor must have sufficient cash reserves to buy the stock at the strike price if the option is exercised.
3. Iron Condor:
   A strategy that involves selling both a call option and a put option at different strike prices, with the same expiration date, and purchasing a call option and a put option at further out-of-the-money strike prices.
   In a word, this strategy allows for limited potential profits while also limiting potential losses.
4. Strangle:
   A strategy where an investor sells both a call option and a put option at different strike prices,
   with the same expiration date, but with the strike prices being far apart.
   In a word, This strategy allows for potentially high profits if the underlying stock moves significantly in one direction or the other, but also has a high risk of loss.
5. Bull Put Spread:
   A strategy where an investor sells a put option at a lower strike price and buys
   a put option at a higher strike price, both with the same expiration date.
   This strategy allows for limited potential profits while also limiting potential losses.

Risk Factors

Call Writing:

1. Unlimited risk:
   The risk in call writing is unlimited because the seller of the call option is obligated to sell the underlying asset at the strike price if the buyer decides to exercise the option.
2. Limited profit potential:
   The profit potential in call writing is limited to the premium received from the buyer of the call option.
   This means that the maximum profit the seller can make is the premium, while the potential losses can be much higher.
3. Market risk:
   Call writers are exposed to market risk, which means that the price of the underlying asset can move in an unfavorable direction, resulting in a loss for the seller.

Put Writing:

1. Limited profit potential:
   The profit potential in put writing is limited to the premium received from the buyer of the put option.
   This means that the maximum profit the seller can make is the premium, while the potential losses can be much higher.
2. High risk of assignment:
   Put writers have a high risk of assignment, which means that the buyer of the put option can exercise the option and sell the underlying asset to the seller at the strike price.
   This can result in a loss for the seller if the market price of the asset is below the strike price.
3. Market risk:
   Put writers are exposed to market risk, which means that the price of the underlying asset
   can move in an unfavorable direction, resulting in a loss for the seller.

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