The majority of retail investors in India are increasing at a historic rate who are wishing to trade in various assets and expand their wealth. One of the ways is trading in derivatives.
However, there are many terms in derivatives which may be confusing to many traders. One of them is Call writing, let’s discuss it in detail with related words.
Table of Contents
What Is Call Writing?
Call writing means Signing a contract to sell or purchase an instrument at a predetermined price on or before a future date. On the expiry date, the call writer is obligated and may be required to sell or buy the security at the strike price.
The person who writes call options is rewarded for entering into the binding contract. In most cases, call options are written in lots of multiple stocks.
The premium for call writing is determined by several factors, including the current stock price, volatility, and the expiry date.
However, after call writer meaning, Let’s understand what are derivatives & how they work?
What are Derivatives?
Derivatives are structured financial contracts that are exchanged on regulated stock markets. They are subject to market regulators’ guidelines, including the Securities and Exchange Board of India (SEBI) in India or the Securities and Exchange Commission in the United States.
They are primarily contracts, with values derived from price movements in their basic assets including shares, commodities, and etc.
Trading Platforms for Derivatives
These derivatives are traded in two ways: one that is subject to specified terms and conditions and hence traded on stock exchanges, and the other that is traded among private counter-parties in the absence of a formal middleman.
The first category is referred to as Exchange Traded Derivatives (ETDs), while the second is referred to as Over the Counter (OTC) derivatives.
Types of Derivatives
Derivatives are classified into two types:
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Future Contracts
A futures contract is a contract among the buyer and seller of a certain asset. Buyers purchase a specified amount of the asset at a specified price payable at a fixed time in the future.
This contract will continue in effect until maturity, at which point investors can sell them for a profit if the price has risen by the time of expiry.
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Option Contracts
An options trading contract is normally authorized in leading securities in which the trader has the right but not the legal responsibility to acquire or sell the purchased securities at a specified price.
Thus a contract allows investors to profit from price swings without having to buy or sell the contract.
How Option Trading Works?
Options contracts, unlike futures contracts, are more flexible since they do not bind the options originator to the contract. If the actual stock’s price falls below the contract price, a client can limit their losses.
As a result, under an options contract, you are not required to buy or sell the contract. However, if you do not purchase, you must pay a premium to the vendor for granting you the privilege for 3 months.
If you choose not to purchase the contract, you will suffer solely this premium as a loss.
Example of Option Trading
Assume you purchase an options contract for 80 kgs of aluminium at Rs 15,000 due in three months (expiry date). You are required to buy the lot before or after the expiration date because you have an options contract.
Consequently, if the price of aluminium falls within 3 months and the 80 kgs of aluminium are for Rs 12,000, exercising your right to buy the contract will result in a Rs 3,000 loss.
Nevertheless, if the price rises to Rs 18,000, you can use your right to buy and profit Rs 3,000.
Types of Option Trading
Option Trading is classified into two types:
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Call Option
A call option is a contract in which you win the right, but not the responsibility, to purchase a certain actual asset at a predetermined price on a mutually agreed-upon date among the contracting parties. Since this call option imposes no duty to buy, you should never exercise it unless it is lucrative to you.
The buying is only beneficial if the previously agreed-upon amount is less than the share price on the date the call option is to be exercised. The strike price is the specified price of the share. Unless your strike price is lower than the share price on the date of execution, you will incur losses through the call option.
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Put Option
A put option works in the exact opposite way as a call option. Whereas the call option gives you the right to acquire the share, the put option gives you the right to sell it at the strike price on the date agreed upon by the contracting parties.
These contracts fundamentally revolve on the actual asset’s possible future price. When you purchase a put option, you are effectively acquiring the right, but not the duty, to sell a certain quantity of the actual asset at a certain price and on a certain date. The contract’s agreed-upon price is known to as the strike price.
Call Writing Meaning
Consider call writing to be an opponent of call options in that if the buyer of an option (call options) makes a profit, the call options writer loses.
A call option, as previously defined, is when a person has the right to buy but not the duty to do so. A call writing, on the other hand, is the procedure through which a seller sells a call option to a buyer.
If the buyer executes the right to purchase, the seller, known as the call writer, is obligated to sell the asset to the buyer.
In the preceding option example, the call options writer is the seller of 80 kg of aluminium, and you are the buyer. The only commitment you have is to pay the call writer a non-refundable charge.
Settlement of Call Writing
For the call writer and the call options purchaser, call writing options must end up in one of 2 circumstances:
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Settlement 1
Since the buyer has the right to purchase the basic asset at the predefined price, the buyer may purchase the call option contract if the strike price (predetermined price) is less than the stop price (the current price).
So the call option writer is required to sell, the buyer receives the contract and the call writer receives the premium.
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Settlement 2
If the strike price of the call option is greater than the market price, the buyer can exercise the right not to purchase to avoid losses. The buyer’s payoff is zero in this situation since he will be unable to sell the contract.
Nevertheless, the buyer must still pay a premium to the call writer, which is the buyer’s only loss.
Advantages of Call Writing
These are the major benefits of call writing:
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Premium
The premium is paid to the call options writer soon after the contract is signed. Additionally, if the buyer does not exercise the purchase right, the premium sum is non-refundable.
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Less Risky
Because a premium is offered for both of the aforementioned possibilities, the call writer is exposed to low risk. Whatever the buyer chooses, the call writer receives a fixed premium.
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Timing
It drives the price of options to decline, lowering the call options writer’s overall risk. After selling the contract to the buyer at a higher cost, the writer can purchase it back at a lesser price.
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Flexibility
Call option writers can shut out their open contracts at any moment before the expiry date. Call option writers can get out of their commitments by purchasing the written open on the secondary market.
Things to Keep in Mind
Call writing options are an excellent technique to protect yourself on both sides of a transaction in the derivatives market. Even if the buyer does not purchase the contract, you can ensure that you limit risk through the premium amount while still holding the options contract.
Moreover, if you are an investor or are willing to trade in the derivatives market, you can look into options to hedge against the risk of other asset classes while making a profit.
Conclusion
Call options, like other investment assets, are exposed to certain risks. Call writers, on average, have a greater chance of succeeding.
This is all from our side regarding Call Writing. Let us know your views in the comment section.
Other Interesting blogs related to Call Writing:
Difference Between Futures and Options
Frequently Asked Questions About Call Writer Means
What is call writing?
Making a contract to sell or acquire an asset at a defined price on or before a future date is called call writing. On the expiry date, the call writer is obligated and may be required to sell or buy the security at the strike price. In most cases, call options are written in lots of multiple units.
Is writing a call bullish?
Covered call writing is appropriate for market conditions ranging from neutral to bullish. Profit potential is limited on the positive side, and on the minus side, there is the whole risk of stock ownership under the breakeven level.
What does it mean to write a call option?
When you write a call, you are selling someone the right to purchase an actual stock from you at a strike price determined by the option series. You are also required to deliver the share if the buyer exercises the call option. As a call writer, you hope for the best that the stock remains idle.
Who is a call writer?
A person who writes or sells an option contract in order to profit from the premium, which is the charge paid by the buyer to the writer. A call option writer commits to sell the actual asset to the call purchaser, who has purchased the right to buy it at a particular price.
What is options writing?
Writing an option is the act of selling an options contract in which the writer receives a fee, or premium, in exchange for the right to buy or sell stocks at a future price and date.
