Quote:
Originally Posted by Joekerr
Question since I know nothing about options - let's say you purchase a call option at a certain strike/exercise price (price doesn't really matter) on the market. Who underwrites these options? Are they individuals?
If so, what happens if that option becomes extremely valuable and you want to exercise it / sell it, but the person underwriting the option can't cover the shares?
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Preconditions :
- Stock BPST (Bimmerpost) is sitting at $10.
- Call option with $12 strike price (commonly written as $12c) with an expiration date 1 month from now
- Individual Jason owns 100 shares of BPST. Jason hates the new 4 series grill so much, he thinks there's no way BPST will be worth $12 in a month - might not dip to $8-$9, but won't hit $12.
- So he sells a covered call as $12c 2-25-21 for $0.15 per share, or $15 (all options are multiplied by 100 shares per contract - 1 contract = 100 shares, so if a contract is $1 cost it's actually $100 total to buy).
- Mark buys the contract from Jason for $15
Scenario 1 :
BPST holds steady below $12 and as of market close on 2-25-21, the stock is worth $11.99 or less. Jason pockets $15 and keeps his 100 shares. Mark loses $15 and gets nothing for it.
Scenario 2 :
BPST holds steady below $12 and as of market close on 2-25-21, the stock is worth $11.99 or less. Jason pockets $15 and keeps his 100 shares. Mark's contract has decreased in value to $0.05 on the morning of expiration, but he doesn't think BPST will hit $12 so he
sells the contract for a $10
loss to Brad. Since the stock closes at $11.99, Mark limited his losses to $10 and Brad loses $5.
Scenario 3 :
BPST rises above $12 and before market close on 2-25-21, the stock is worth $12.15 or more. As the strike price on the contract is $0.15 per share, this now makes it worth it to Mark to
exercise the contract and purchase those 100 shares at a price of $12.15 each. This means he must have $1,250 cash in his account in order to exercise, plus any transaction / trading fees by his brokerage. Jason gains $1,265, but loses his 100 shares. Mark now owns 100 shares of BPST, at an average cost of $12.15. As the price is now above his purchase price, let's say $13, Mark could immediately turn around and sell his shares for a $0.75 profit per share, making $1,300 on the sale. Subtracting his $1,250 cost, Mark just made $75.
Scenario 4 : BPST rises above $12 and before market close on 2-25-21, the stock is worth $12.15 or more. The contract is now "In the money" and worth say, $0.45 rather than the $0.15 Jason sold it for. Since Mark now owns the contract, he may choose to simply
sell it rather than exercise - maybe he doesn't have enough cash to exercise it. Mark sells the contract to Brad for $0.45, and pockets $45. Minus his $15 to purchase the contract, Mark just made $30, Jason made $15, and Brad has the option to exercise the contract and purchase the shares for $12.45 break-even price.
There are a few other ways it could play out and my numbers are probably a tiny bit off, since we didn't go into the greeks, but hopefully you get the gist here.
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