Writing a short duration put

You are about to write a limited buy order on a very liquid stock. Imagine what your stock broker might do.

Bullish call option spreads

Time value

Speculators familiar with buying options know it too well: the option value erodes over time if the stock stays level. The option value is composed of two components:

·         Intrinsic value (for a call option above strike or a put option below strike)

·         Time value

While the intrinsic value only depends on the option strike and the share price, time value is a different animal. It is larger for a stock that is most likely to end up ‘in the money’. Hence the time premium is higher the more of the following clauses are fulfilled:

·         the stock price is pretty close to the strike (the option is ‘near the money’),

·         the option has some time left for the stock to pass the strike price,

·         the underlying exhibits a high volatility, making it more likely for the stock to bridge the gap to the strike price.

‘Selling options’

It has many names: going short an option, writing an option, selling an option.

An option basicly concerns a tradable contract initiated by the party going short the option. Without any party going short, there can be no options. Going short an option is no equivalent of going short stocks, in which case the shorter needs borrowing the stock to sell straight away. He ‘s counting on it to cover later at a lower price and return the stock to the lender.

Options are created ‘out of thin air’. There are professional parties selling and buying options (both call and put options) for different strike prices and expiry dates. They provide liquidity in option contracts to the market and earn their living mainly from the bid-ask spread. There may not be a bid price for options about to expire worthless. The total number of options written 'out of thin air' is the open interest. The higher the open interest, the more liquid an option contract is likely to be.