Buying vs. Writing Options: Rights, Obligations and Risks
Buying an option means paying a premium for a right: to buy at the strike (a call) or to sell at the strike (a put). Writing (selling) an option means receiving that premium in exchange for an obligation: to sell or to buy at the strike if the buyer exercises. The buyer's loss is capped at the premium; the writer's gain is capped at the premium and the loss can be much larger. This guide from OptionLab (option-graph.com) compares the four basic positions -- long call, short call, long put and short put -- with numbers, charts and the risks of each side.
The Four Basic Positions
Rights and obligations of the four basic positions
Four boxes. Call buyer and put buyer each hold a right to buy or sell at the strike, pay the premium and can lose at most the premium. Call writer and put writer each carry an obligation to sell or buy at the strike if exercised, receive the premium and can lose far more than the premium.
Buyer (holder) · Call
- Right to buy at the strike
- Pays the premium
- Most it can lose: the premium
Buyer (holder) · Put
- Right to sell at the strike
- Pays the premium
- Most it can lose: the premium
Writer (seller) · Call
- Obligation to sell at the strike if exercised
- Receives the premium
- Loss can be far larger than the premium
Writer (seller) · Put
- Obligation to buy at the strike if exercised
- Receives the premium
- Loss can be far larger than the premium
- Simplified: margin, early exercise and fees are not shown
Every option trade puts one participant in each column. When you buy a call, someone has written it; when you write a put, someone holds the right to sell to you. On option-graph.com a single switch between Buy and Sell turns one side into the other, which is the quickest way to see that the two payoffs are exact mirror images.
What the Buyer Gets -- and Risks
The buyer's position is defined in advance: the most it can lose is the premium, whatever happens to the underlying. In exchange, the buyer needs the move to be large enough, and soon enough, to cover that premium. A call with a $100 strike bought for $4.00 per share costs $400 for one contract of 100 shares. At expiration with the stock at $115 it is worth $15 per share, and the result is +$1,100. With the stock at $104 it breaks even; below $100 it expires worthless and the buyer loses $400. Entered on option-graph.com, the same numbers show the $104 breakeven directly on the chart.
What the Writer Gets -- and Risks
The writer of that same call receives the $400 up front. If the stock finishes below $100 -- at $90, for example -- the call expires worthless and the writer keeps the full premium: +$400. If the stock finishes at $115, the writer must deliver at $100 something worth $115 and the result is −$1,100. Because a stock price has no ceiling, an uncovered call writer has no fixed limit on the loss. On option-graph.com the chart of this position keeps falling to the right edge of whatever range you choose -- that is what an open-ended loss looks like.
Writing one call: $100 strike, $4 premium
Profit zoneLoss zoneK = StrikeBE = Breakeven
| Point | US dollars per contract (100 shares) |
|---|---|
| Strike 100 | +400 |
| Breakeven 104 | 0 |
| P/L at 80 | +400 |
| P/L at 130 | −2,600 |
- One contract = 100 shares
- Premium $4.00 per share received
- Held to expiration; margin, commissions and taxes not shown
Writing a put is the other common case. A writer who sells a put with a $95 strike for $3.00 per share receives $300. If the stock stays above $95 -- at $100, say -- the put expires and the writer keeps +$300. If the stock falls to $80, the writer must buy at $95 something worth $80: the result is −$1,200. The loss is limited only by the stock's fall to zero. You can enter both trades on option-graph.com and compare their breakevens and worst cases.
Margin: Why Writing Ties Up Capital
Because the writer's obligation can cost far more than the premium, the exchange or broker requires collateral (margin) for as long as the position is open. Margin can increase when the market moves against the writer, which may force a decision before expiration. A premium received is therefore not a profit yet: it is a payment in exchange for a risk that stays open until the option expires or is bought back. When you model a written option on option-graph.com, look at the loss side of the chart, not only the premium.
Choosing a Side Is Choosing a Risk Profile
| Buyer (long) | Writer (short) | |
|---|---|---|
| Pays or receives | Pays the premium | Receives the premium |
| Most it can gain | Call: open-ended; put: strike minus premium | The premium |
| Most it can lose | The premium | Call: open-ended; put: strike minus premium |
| Needs | A large enough move before expiration | The move to stay small enough |
| Time passing | Usually works against it | Usually works for it |
Neither side is better. A buyer pays for a limited loss and a chance at a large gain; a writer accepts a limited gain and a chance of a large loss. The probabilities, the size of the outcomes and the cost of margin all matter, and they differ from trade to trade. The payoff charts on option-graph.com show both shapes for your own strike and premium.
Risks and Limitations
Buyers often lose the whole premium. Writers can lose much more than they receive, may face margin calls and may be assigned at an inconvenient time. Spreads and commissions reduce every result. Results before expiration also depend on time and volatility, not only on the price. Options are not suitable for every investor. OptionLab (option-graph.com) is an educational and analytical tool and does not provide investment advice. Check the worst case of any written option on option-graph.com or with your broker before trading.
Summary
- Buyers pay a premium for a right; writers receive it for an obligation.
- The buyer's loss is capped at the premium; the writer's gain is capped at the premium.
- Writers post margin, and a premium received is not a profit until the risk is closed.
- Model both sides of the same option on option-graph.com before choosing one.