Throughout the course of this chapter, a symmetry in the P&L graph of an option seller has become apparent. We have concluded that there is a connection between the call option buyer and the seller. This is evident when plotting their respective gains and losses.
The call option seller’s P&L payoff appears to be a reflection of the call option buyer’s P&L benefit. The chart above makes it clear that the conversation we just had is accurate; you can see points such as…
– A note on margins
The risk exposure differs for a call option buyer and seller. The buyer has limited risk as they only need to pay the premium to the seller in exchange for the right to buy the underlying asset at a later date. It is important to note that their maximum loss is restricted to the premium paid.
When it comes to the risk profile of a call option seller, an unlimited loss potential exists; as the spot price moves higher than the strike, this risk increases. This creates a challenge for stock exchanges – how can they limit the exposure of such an option seller when faced with the possibility of enormous losses and prospective defaults?
Clearly, the stock exchange cannot accept such a large default risk from a derivative participant, thus the option seller must deposit funds as margins. This margin requirement for an option seller is similar to that for a futures contract.
– Putting things together
I hope the past four chapters have provided you with all the understanding necessary for purchasing and selling call options. Options are more complex than some other topics in finance, so it is advisable to summarise our learning whenever there is an opportunity and move on. Here are some of the key points to keep in mind with regard to buying and selling call options.
With respect to option buying
With respect to option selling
Other important points