Long Index Put - The Risk

[John26]

Hi,

I bought some FTSE 100 Put 18-03-16 £5800.
My understanding is that I cannot lose more than I have invested regardless of my actions with these puts going forward.

My mate said last night that there is a risk in selling them because if I sell and it becomes ITM? He said I become the writer and that introduces unlimited risk. Is that correct? I didn't want to argue because he almost sounded like he knew what he was talking about.

I did my homework before embarking on this and I thought that long puts and long calls on Index Options had limited risks (amount paid at purchase) and that I could not lose anymore than that regardless of what I do with these.

Thanks

 

[StewartC]

You are right. Your loss is limited to the premium you paid, max loss if FTSE is above 5800 at expiry.

 

[John26]

You are right. Your loss is limited to the premium you paid, max loss if FTSE is above 5800 at expiry.

Thanks Stewart, that's comforting
Now, just so that I am clear (because I saw some horror stories whilst looking into this and didn't sleep too well last night):

1 - Buying calls or puts in Index Options are always only as risky as the premium paid, we're good with that, so if i'm otm, i can trade (sell) my options with no further possible liability or let it expire and cash out at expiry if ITM?
2 - Naked trading only applies to selling before buying (short, then cover)
3 - Naked trading only applies to stock options not index options
4 - Can anyone recommend good books/ sites about options (UK centric as I understand that in US options trade a little differently).

Cheers

 

[StewartC]

Thanks Stewart, that's comforting
Now, just so that I am clear (because I saw some horror stories whilst looking into this and didn't sleep too well last night):

1 - Buying calls or puts in Index Options are always only as risky as the premium paid, we're good with that, so if i'm otm, i can trade (sell) my options with no further possible liability or let it expire and cash out at expiry if ITM?
2 - Naked trading only applies to selling before buying (short, then cover)
3 - Naked trading only applies to stock options not index options
4 - Can anyone recommend good books/ sites about options (UK centric as I understand that in US options trade a little differently).

Cheers

1. Depends how you define risk. Yes your max loss might be limited, but buying a far-OTM option may have only a 5% chance of profit at expiry, so high risk of total loss. Selling a put on a quality, low-volatility stock is arguably lower risk.
2/3. Naked means without a position in the underlying or another option to hedge, so it can be either. Also either stock or index
4. UK traders can trade European or American-style options. Basic education is here: http://www.optionseducation.org/en.html

 

[John26]

2/3. Naked means without a position in the underlying or another option to hedge, so it can be either. Also either stock or index

It can be either? Sorry, I now feel I am missing a crucial point.
How does naked trading apply to long put sellers [which could be my situation if i decided tomorrow to sell my puts on ftse100]...
I must have got this so wrong and you probably think my brain is a mess:-0

 

[StewartC]

If you sell to close the put you bought, you won't have a position at all.

Sorry to confuse - naked typically only refers to selling options first without cover, but my point is you can have significant risk in speculative buying.

 

[John26]

If you sell to close the put you bought, you won't have a position at all.

Sorry to confuse - naked typically only refers to selling options first without cover, but my point is you can have significant risk in speculative buying.

Naked means without a position you said, so I'll be naked (and exposed) if I sell my put?

Perhaps someone need to explain in a 2 or 3 steps what I would have to do to find myself naked after buying calls or puts on Index - because I didn't think that was possible based on what I thought and your first reply.

 

[StewartC]

Buy to open a put - you have a position in the market
Sell to close that same put - you have no position at all, you no longer have any exposure.

Examples:
If you simply hold shares in a stock - you have a naked position
If you also write (sell) a put (or call) on that stock - your position is covered

If you buy (or sell) a call (or put) on its own - you have a naked position
If you also sell (or buy) another option on that stock or the underlying stock - your position is covered

 

[John26]

If you buy (or sell) a call (or put) on its own ...

Which is what I did: Bought a put on its own

... you have a naked position

So I am currently naked with my puts?

If so, I always believed that being naked exposes one to potential unlimited loss.

I already think I've taken enough of your time here, plus it's sunny today. If it's too complicated, don't worry, I'll try and find a good book. I thought I was good with the basics but I obviously have a few gaps that need filling.

Cheers.

 

[options-george]

John, I would suggest that you don't trade any more options for now, and instead invest a chunk of hours in studying how options work. I found most large bookstores will have some textbooks introducing options trading. They should be 200+ pages long. Most of these will do. Additionally, there already is a lot of information in the sticky T2W threads in the futures/options section which should be quite helpful.

Based on the questions you are asking, I would think that you may not have sufficient knowledge to actually trade in options. The points you are asking about are elementary aspects of trading in options. Hence most answers will likely lead to more questions. I am not saying this to be mean or disrespectful - rather I am trying to prevent you from losing money that you don't need to lose. It's important to understand, IMHO, option trading is a lot more complicated than trading outright instruments.

Again, please don't be offended by my reply - I am trying to give (what i think is) good solid advice, and to steer you away from being caught in nasty spots.



I tried to put a general warning about this earlier this month.

http://www.trade2win.com/boards/futures-options/212708-options-trading-warning.html

 

[John26]

John, I would suggest that you don't trade any more options for now, and instead invest a chunk of hours in studying how options work. I found most large bookstores will have some textbooks introducing options trading. They should be 200+ pages long. Most of these will do. Additionally, there already is a lot of information in the sticky T2W threads in the futures/options section which should be quite helpful.

Based on the questions you are asking, I would think that you may not have sufficient knowledge to actually trade in options. The points you are asking about are elementary aspects of trading in options. Hence most answers will likely lead to more questions. I am not saying this to be mean or disrespectful - rather I am trying to prevent you from losing money that you don't need to lose. It's important to understand, IMHO, option trading is a lot more complicated than trading outright instruments.

Again, please don't be offended by my reply - I am trying to give (what i think is) good solid advice, and to steer you away from being caught in nasty spots.



I tried to put a general warning about this earlier this month.

http://www.trade2win.com/boards/futures-options/212708-options-trading-warning.html

Thanks George, I really appreciate that and I do understand you're trying to help.

At least I am safe with the options (in a way that I can only lose what I have invested) I hold and I understand that the max I can lose is what I paid for and I am fine with that (I bought £1k worth).
Would you mind just helping me with this one:
I believe I have 3 options:
1 - Sell my options OTM because this is not going my way and all I'll lose is what I paid for - what I get when I sell
2 - Exercise it and cash in when ITM (if I think FTSE will bounce back up )
3 - Hold it to expiration and cash in at expiration if ITM or nothing if OTM

I will definitely be looking for a good book today

Thanks very much

 

[options-george]

Thanks George, I really appreciate that and I do understand you're trying to help.

At least I am safe with the options (in a way that I can only lose what I have invested) I hold and I understand that the max I can lose is what I paid for and I am fine with that (I bought £1k worth).
Would you mind just helping me with this one:
I believe I have 3 options:
1 - Sell my options OTM because this is not going my way and all I'll lose is what I paid for - what I get when I sell
2 - Exercise it and cash in when ITM (if I think FTSE will bounce back up )
3 - Hold it to expiration and cash in at expiration if ITM or nothing if OTM

I will definitely be looking for a good book today

Thanks very much

Well I am glad my message came across the right way

Yes, if you have bought options, then the most you can lose is what you paid for them, i.e. £1k.

Yes, you can sell the options OTM and your loss will be the difference between what you paid for them and what you end up selling them for.

You can also sell the options at any time if they are ITM, again the profit/loss will be the difference between purchase price and selling price.

Yes you could exercise the option before expiration date, however this is not a good idea, because you are basically giving away the "time value" component of the option [you will learn about that when you read the book]. In other words, option exercise should generally only be done on expiration, and not before then.

Rather than exercising the option on expiration date (if it is ITM) you could also simply the option for a profit, rather than go through the exercise process.

Good luck.

 

[John26]

Well I am glad my message came across the right way

Yes, if you have bought options, then the most you can lose is what you paid for them, i.e. £1k.

Yes, you can sell the options OTM and your loss will be the difference between what you paid for them and what you end up selling them for.

You can also sell the options at any time if they are ITM, again the profit/loss will be the difference between purchase price and selling price.

Yes you could exercise the option before expiration date, however this is not a good idea, because you are basically giving away the "time value" component of the option [you will learn about that when you read the book]. In other words, option exercise should generally only be done on expiration, and not before then.

Rather than exercising the option on expiration date (if it is ITM) you could also simply the option for a profit, rather than go through the exercise process.

Good luck.

Thanks, you guys rock on this forum - A lot of people would have (rightly) given up.

I am going to order these:
http://www.amazon.co.uk/dp/02737590...UTF8&colid=AOXNVK3BK4OQ&coliid=I3AUUD06O9K6Q4
http://www.amazon.co.uk/dp/15573848...UTF8&colid=AOXNVK3BK4OQ&coliid=I3HB3BO68C2YDG

One last final question, and then I'll vanish for a bit:
If I sell before expiry, do I not become the writer who could be assigned in case the put becomes ITM by the guy who buys it from me, say the ftse drops to 4000 before expiry, I would owe him/her thousands.
Or is the writer (the one who can be assigned) static? ie: the one who originally issued the option, rather than roaming around from buyer to seller passing the ball?

Thanks.

 

[options-george]

Thanks, you guys rock on this forum - A lot of people would have (rightly) given up.

I am going to order these:
http://www.amazon.co.uk/dp/02737590...UTF8&colid=AOXNVK3BK4OQ&coliid=I3AUUD06O9K6Q4
http://www.amazon.co.uk/dp/15573848...UTF8&colid=AOXNVK3BK4OQ&coliid=I3HB3BO68C2YDG

One last final question, and then I'll vanish for a bit:
If I sell before expiry, do I not become the writer who could be assigned in case the put becomes ITM by the guy who buys it from me, say the ftse drops to 4000 before expiry, I would owe him/her thousands.
Or is the writer (the one who can be assigned) static? ie: the one who originally issued the option, rather than roaming around from buyer to seller passing the ball?

Thanks.

In answer to your question, you are getting some of it correct - good

If you initially bought an option, and then you sell it - then this means you no longer have a position in the market. You have NOT become the writer.
The writer was the person who initially sold you the put option that you bought.

You only become the writer if you are selling to open a new position. You do not become the writer when selling to close an open position.

In the books you should also come across a term called "open interest" - this is the total volume of open positions in a particular option chain, eg the FTSE March2016 5800 puts (I made that one up - not sure how exactly the FTSE options are quoted).

When you bought your put, the open interest in that option chain increased by 1 (assuming you bought 1 contract). When you close the position, i.e. when you sell it, the open interest will decreased by 1. Again, I have simplified this somewhat for the purpose of explaining it here. But if you think about it from that angle, it may help you understand who the writer is.

You can think of an insurance contract as an analogy. You take home insurance on your home - this is like a put option - if something terrible were to happen to your home then you would get a payout - in other words the insurance contract/put option becomes valuable. The insurance company is the WRITER.
Part way through the year you decide to cancel the insurance contract - you get a partial refund. Thus you made a loss by buying and then selling the put option. The insurance contract now no longer exits. You did not become a writer by cancelling/selling your insurance contract/put option.

In terms of the books - the Natenberg was considered very highly in the industry when I was working with the options market-maker (back in 2006!). In fact he sent me down to the bookstore and made me study the entire book and then gave me tests on it. So I can highly recommend this book - however I have to warn that it's got a lot of material in it, and it is only partially introductory. I have not heard of the other book.

Good luck.

 

[John26]

In answer to your question, you are getting some of it correct - good

If you initially bought an option, and then you sell it - then this means you no longer have a position in the market. You have NOT become the writer.
The writer was the person who initially sold you the put option that you bought.

You only become the writer if you are selling to open a new position. You do not become the writer when selling to close an open position.

In the books you should also come across a term called "open interest" - this is the total volume of open positions in a particular option chain, eg the FTSE March2016 5800 puts (I made that one up - not sure how exactly the FTSE options are quoted).

When you bought your put, the open interest in that option chain increased by 1 (assuming you bought 1 contract). When you close the position, i.e. when you sell it, the open interest will decreased by 1. Again, I have simplified this somewhat for the purpose of explaining it here. But if you think about it from that angle, it may help you understand who the writer is.

You can think of an insurance contract as an analogy. You take home insurance on your home - this is like a put option - if something terrible were to happen to your home then you would get a payout - in other words the insurance contract/put option becomes valuable. The insurance company is the WRITER.
Part way through the year you decide to cancel the insurance contract - you get a partial refund. Thus you made a loss by buying and then selling the put option. The insurance contract now no longer exits. You did not become a writer by cancelling/selling your insurance contract/put option.

In terms of the books - the Natenberg was considered very highly in the industry when I was working with the options market-maker (back in 2006!). In fact he sent me down to the bookstore and made me study the entire book and then gave me tests on it. So I can highly recommend this book - however I have to warn that it's got a lot of material in it, and it is only partially introductory. I have not heard of the other book.

Good luck.

Ok, thanks for your time George, much appreciated. It's all beginning to make sense.
However.... when I sell my put (because I can't see it becoming a winner for instance), the guy who buys it from me, might have a winner down the line before it expire if the ftse drops enough, if he exercises it, who will it be assigned to; ie who will pay him/her? I think, it might be the original issuer? Is this correct? If so, can I assume that as a retail investor, I don't actually issue options.

Another question, (please tell me when you've had enough of me) ...

From http://www.success-with-options.com/index-option-trading.html This is what I read:

One advantage with index option trading is that fact that they are European style exercise. That means if ther was a case where the position went against me and I was in the money, I am not in danger of being assigned unless I hold it until expiration.

Ok, so FTSE 100 put, I assume this is European style? (can't seem to find a definite list of euro/us style options) - I can't even find info re FT55 (my option epic!) - Anyway, what this chap is saying is that I should not hold it to expiration! Just when I thought I'd grasped it. Jesus, is the topic of options post-graduate level? :smart:lol

Cheers

PS: If I see you in town, I will buy you a pint mate

 

[options-george]

These last couple of questions I am not sure about.

Firstly I think it might depend on the option attributes - some will be different than others - with US stock options (if I remember correctly) any options that are exercised are randomly allocated to anyone with a short position in that option on expiration day. I don't think the individual option contracts are actually tracked with serial numbers or something like that. But I guess it's not vital for you to know this detail.

It is definitely possible for a retail trader to be exercised against on expiration day, because retail traders are able to hold short positions in an option if they wish to do so. Most of the time they would not hold outright short positions such as being short the 5800 put, but they could have sold the 5800-5600 put spread (short 5800 puts, buy 5600 put [this is an example of a credit spread]. If the FTSE closes at 5700 the short leg of the spread will be ITM, whereas the long leg will not be. You would be assigned on the 5800 put.

Do you know see what I mean by me saying every question/answer is likely to lead to more questions?

I don't know a lot about the difference between US style and European style options so I would prefer to not comment on that one.

Your time is probably also well spent on that site that you linked to, since it's option-specific.

Right I better get into my trading now :cheesy:

(Yes, definitely up for a pint [or coffee!])

 

[John26]

@options-george
@StewartC
George, Stewart, thanks very much for your time. You guys are champs - I have learned quite a lot from you both, I really appreciate your help. :clap:

Cheers.

 

[options-george]

@options-george
@StewartC
George, Stewart, thanks very much for your time. You guys are champs - I have learned quite a lot from you both, I really appreciate your help. :clap:

Cheers.

You are welcome!

I think this is partly what the T2W forum is meant to be for, right?

Additional sources you could try are a couple of titles written by Lawrence McMillan. (easily found on Amazon). Some were written a while ago, but I remember some of my friends finding them good reads.

 

[apau]

Options George, after a discussion John26 has bought a warrant.