[sasham]

Help me understand this. I write a put when the stock price is $100. The strike price is $110 and the stock price drops to $80. I see I have loss now. $110-$100=$10 is my intrinsic value. So is $80-$10=$70 my loss?

[ArcSine]

You have a $30 loss as a result of the put being exercised against you. But that's partially mitigated by the premium from when you sold the put (remember, you're the option writer here).

Your actual net loss on strike date is the $30, less the forward value of the premium (you've had benefit of the put's premium from the day you wrote the option).

[sasham]

I had the same answer like yours $30, but in my test it says its not right, so I didn't pass... But now they gave me options that it could be $20, $40 or $70... I'm confused...

[ArcSine]

Don't forget the premium. I said that the loss is $30 less the premium's forward value. If, for example, you sold the put for $10, then your net loss is $20.

Same result if you sold the put for $9.25, which grew to $10 by the time the option was exercised. (That's why I referred to the put's forward value--but your test question, for simplicity, might not introduce that particular wrinkle, and simply consider the loss as being the exercise loss, net of the premium.)

Note, for example, that if you wrote that put with a strike of 110 when the stock was trading at 100, then right out of the gate you've got a built-in loss of 10, if the exercise date is imminent. You'd thus need to sell that option for a minimum of 10 under such circumstances.

[sasham]

Thank u! Thank u!! There is no word about forward value and only couple sentences about writing calls in my book. Just want to ask u one more thing - when selling the call,my maximum loss is unlimited and maximum gain then is price of the call?

[sasham]

Bur is it the same situation when the option is near expiration and the market doesn't assign any additional value to the option's intrinsic value? I'm having the same loss?

[ArcSine]

Yes, when you sell a call, your potential downside is theoretically unlimited, although as a practical matter it's unlikely that a stock that's trading at, say, 35, will suddenly begin trading at a gazillion or so.

Nevertheless, always be very aware of a realistic loss exposure if you're going to short calls. Your maximum gain occurs when the option expires unexercised, and this gain is the call premium you sold it for.

[sasham]

Thanks!! Was nice "talking" with u :)
Have couple more problems in this area, will post them in separate posts.

[ArcSine]

Nice chatting with you as well... I enjoyed it! Take care,