Writing An Option

Writing a put or call option refers to an investment contract in which a fee is paid for the right to buy or sell shares at a future date. Put and call options for stocks are typically sold in lots of 100 shares.

Writing an option is a fundamental investment strategy dating back to ancient times in which an investor seeks to make money by correctly predicting future price movements in a stock or commodity. For example, a farmer growing corn may believe that current drought conditions will not persist into the next growing season, so he writes call options on the future price of corn. As the buyer of corn options, the farmer is granted the right to buy at a specified price in the future. This type of buy option is known as a call. The seller of an options contract must sell at the specified price, so in this case the farmer hopes to buy low and reap the rewards of the improved growing conditions for commodities once the drought ends.

Options contracts are commonly used as a short-term trading strategy by stock investors looking to make money from their charting observations. Day traders use a variety of charting techniques to identity the trading ranges of a stock, with particular attention given to the reversal zones when a price begins moving in the opposite direction from recent movements. When writing an option, the price of the stock or commodity available for sale or purchase is known as the strike price. The strike price intervals vary when the contract is written, with higher-priced equities typically using $5 intervals while lower-priced equities use $2 intervals.

An options contract will have an expiration date typically occurring in calendar year quarters. The fee, or premium, paid when writing an option depends upon several factors including the current price of the stock, when the strike date occurs and other factors such as the asset’s volatility.

As is true for many modern trading concepts, the origins of writing an option date back to ancient times. Aristotle, the Greek philosopher who wrote about many topics, recorded an early example of options trading in his seminal work Politics. The philosopher and mathematician Thales of Miletus studied astronomy as a way to predict olive harvests for his region. Thales believed there would be a coming bountiful olive harvest, but did not have the money to buy his own olive presses, so instead paid a fee for the right to access the olive presses of others.

In essence, this was an example of the first options contract as he bought the right to an asset but not the obligations of ownership. When it turned out he was correct and a bountiful olive harvest did follow, he exercised his option in gaining access to the olive presses, thus benefiting from his speculation on the future.