Comment Synopsis This edition covers the role of option sellers and how their activity can help interpret prices. This edition deals with the role played by option sellers and how their options activity can help market constituents interpret prices having topped or bottomed.
The buildup of open interest OI at certain option strikes or levels by the sellers is thus an important indicator. Read on… 1.
What are options? Instruments that facilitate the purchase or sale of an underlying commodity like gold, silver, copper, etc, for a fixed price on a future date. A hedger typically buys a put option or sells a call option as the risk it faces is a fall in the prices of goods it sells. A speculator, on the other hand, takes on the risk that the hedger seeks to cover against by assuming a contrary position.
Options and Futures
If the hedger purchases a put option in the belief prices of an asset could correct, a speculator would sell that put to it. Or, if the hedger sells a call a speculator would buy it.
Are options similar to futures contracts? Yes, but, unlike futures, where a buyer or seller must pay an upfront margin to trade and can be exposed to unlimited profits and losses, an option buyer pays a premium to buy a call or put and the premium is the maximum she can lose.
Her gains could be unlimited. On the other hand, an option seller what is buyer s option limited profit as her maximum gain is limited to the premium received from a call or put buyer while losses could be unlimited unless a stop loss is placed. A call option buyer gains when an underlier expires or trades above the strike level purchased plus premium paid.
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That means she is bullish. If her call is correct she makes money.
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Who loses? A call seller who is her counterparty to the trade.
- In commercial contracts, a buyer's option is an agreement between a vendor and a buyer that defines price and specifications over a specified period for a product.
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The call seller gains only if an underlier trades below the strike sold plus the premium she receives. Similarly, a put buyer gains if an underlier falls below the strike purchased minus premium paid by her.
She is bearish. If her call is correct, she makes money from the counterparty who has sold her the put, being bullish. The put seller gains only if the underlier trades above the strike sold minus the premium received from the put buyer.
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This leads to the following relative situation: a call buyer is bullish, a call seller is bearish; a put buyer is bearish, a what is buyer s option seller is bullish. Since the options seller receives premium and faces unlimited risk, she tends to be better informed and more well-heeled than options buyers. She may also have sold options against underlying stock she owns or as a hedge against her futures positions.
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The commodity tends to respect these price levels where OI is large. The levels can shift if the price breaks out.
This edition covers the role of option sellers and how their activity can help interpret prices.
Also, option sellers hedge themselves against losses by charging higher premiums in cases where a commodity tends to be more volatile. For e. Is trading in options risky? Trading in derivatives is risky and only informed investors should participate. Often, however, gullible investors tempted to earn huge returns enter without understanding the attendant risks.
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