Under what condition would a "buy to open" call option expire worthless?
I did a "sell to open" put option, which expired with the stock price being below the strike price, and I purchased the stock at the strike price. So I wanted to initiate a call option to sell the stock at the same strike price, however, I'm not confident I did this correctly to accomplish my objective. I initiated a "buy to open" call option to sell the stock at the same strike price. I feel I should have done a "sell to open" call option and not the "buy to open" call option; it makes more sense now to "sell" it and not "buy" it, but I'm stuck with it. Obviously I'm new at this. Now that I have this "buy to open" call option on the table, I'm not sure of the outcome when it expires. Does it expire worthless when the stock is above the strike price or below the strike price? Do I initiate a "sell to close" (not sure if a put or call is associated with this) option when the stock price goes up or when the stock price goes down before it expires?
Sell to open on a put option means that you sell a put option to the buyer which gives the buyer the right to sell you stock at the strike price. Since the stock price was below the strike price, you were obligated to buy the stock at the strike price. If you wanted to open up a new option position, that would give you the right to sell the stock at the same strike price you should have bought a put or "buy to open" on a put option. This would give you the right but not the obligation to sell your stock at a certain strike price.
You initiated a "buy to open" call option which gives you the option to buy the stock at a certain strike price. The holder of a call option hopes the price of the stock rises so they can buy that stock at the strike price.
You think you should have initiated a "sell to open" call option which would oblige you to sell your stock at a certain strike price if the holder exercises. This isn't the outcome you want because the holder will only exercise if the stock price rises and you would be selling it at a loss.
On your current contract, if the stock price is above the strike price, you can sell the option for a profit, you should initiate a "sell to close". If the stock price is below the strike price, then the option will expire worthless.
Read up on options before you deal with them, they can be complicated and confusing and you can really burn yourself. Practice as well before you actually start trading real money.
Thank you for your question: (See definitions below)
As the seller of the put option you were assigned the stock because stock price was below the strike price. You had a few choices at that time a) Sell the stock at a loss. b) Hold on to the stock c) With the stock price below the original strike price, if you wanted to sell the stock at that original strike price and collect a premium for waiting, using an option, you would have had to sell a call at that original strike price. You would have received a premium and if and when the stock price went back up to that strike price, your stock would have been called away. On the other hand, if the stock fell, you would have suffered further losses. d) If your objective was to protect the stock that was assigned to you, you would have had to buy a put. But, you would ideally do it at the current stock price or below (you would do it at a higher price, paying a higher premium, in some cases).
Instead, you bought a call at that strike price by mistake- which essentially meant you had double the exposure to the stock. At expiration, if the stock price is higher than the strike price, you have a choice. 1) Do nothing, in which case as a holder of the call you will get the profits 2) Exercise the option in which case you will get to own the stock (In addition to the stock you already were assigned through the put).
At expiration, if stock price is below strike price, your call option will expire worthless.
Finally, having bought the call unintentionally, if you wanted to close the position out before expiration, you would 'sell to close' the call option and depending on the underlying stock price it would be at a loss or gain.
1) A put option gives the buyer (holder) the right but not the obligation to sell the stock at a particular price (Strike price) at a particular time. (Limited loss, unlimited gain) Conversely, the seller of the put is OBLIGATED to honor the contract if the holder wants it. (Limited gain, unlimited loss). If the stock price is below the strike price at expiration, the holder's position is profitable and the seller's is unprofitable.
2) It is the reverse for a call option- call option gives the buyer the right to purchase the stock at a particular strike price. If the stock price is above the strike price at expiration, the holder's position is profitable and the seller's is unprofitable.
3) As a buyer of an option, you will be assigned the stock only if you exercise it. If not, if the option is profitable, you will get the $ difference at expiration. If the option is unprofitable at expiration, it expires worthless. In the case of a put, the seller will get 'assigned' the stock if the stock price is below exercise price and the buyer exercises it . If the seller does not want to be assigned the stock, she has to cover it (ie buy it) before expiration. The seller of a call gets the stock 'called away' if the stock price is above the strike price and she owns the stock. If she does not own it, she will be short the stock.
4) When you have the words 'to open' in an order it is the first leg of any trade. So 'buy to open' means buy first (And then sell). 'Sell to open' means sell first. 'To close' is the second leg, ie the trade to close the position.
You are correct in that you wanted to "sell to open" the call option to create a covered call combination. No worries though. You can simply sell two calls at the same strike and expiration. This sells the long call and establishes a short call against your long stock. The key is to remember that short options can create unlimited loss potential so always know how you are covered or hedged. In the case of the short put, you were likely "cash covered" meaning you had enough cash to buy the stock at the strike price. A short call is covered by owning the underlying stock. Go slow and trade small. You will get the hang of it!
A call is the right to buy, and a put is the right to sell. Just remember if you buy a call, you can "call" them up for the stock (make them sell it to you), and if you buy a put, you can "put" the stock to them. If you purchase an option, you have the right but not the obligation to exercise. If you sell an option, you take in money, the premium, and have the obligation if exercised.
So if you sell a put to open, you took money in return for agreeing to buy the stock a the specified strike price. If the stock is below the strike price at expiration, it will automatically be exercised because it is "in the money" and didn't expire worthless. So you will either have to buy those shares at the strike price or deliver the stock you own. If you own the shares, this is a covered position (versus a naked or uncovered position).
There is no such thing as call option "to sell" the stock," it would have to be a put option "to sell." Remember, a call is the right to buy and a put is the right to sell. Just like buying & then selling a stock has two parts to consummate the transaction, so do options. Now normally you buy a stock (to open) first then sell (to close), but you could also sell short first (to open), then buy back the stock to cover your short (to close). With options, you alway either buy or sell "to open" the position, and then do the opposite buy or sell "to close" the position (assuming it didn't get exercised or expire worthless).
Whenever you purchase/buy and option, your maximum loss is the premium you paid (ignoring trading costs). But when you sell/write an option, your losses can be huge if naked. If you own the underlying security/stock, your loss is limited or even a gain if successful.
This is because if you sell a call, say with a strike of $100, the stock could go to $200 or $300, and you would have to go and buy the stock in the market to deliver if you didn't own the underlying stock to deliver. This is known as "covered call." So theoretically, a if you sell a naked call, you loss could be infinity because the stock can go up indefinitely. In reality, it won't, but you don't know how high it could go. With a naked put, your maximum loss is the strike price ($100) minus the premium you took in. This is because if the stock is capped a zero if the company goes bankrupt. This is also remote if using large, solid companies.
In your example, if you wanted to sell or "put" the stock to someone, you need to initiate a "buy to open" put. This would be for insurance or to make money if you thought the stock is going down. You could sell a call to open if you thought the stock was going down, but if it went up you would lose money unless you were doing a covered call and owned the stock. The most common option strategy is a covered call to create "income." I consider it a reduction of principal until the trade in unwound.
In your example, if you did an uncovered or naked sell to open call, if the stock goes down it will expire worthless and you made the premium. If it goes up, you will have a loss. You have 2 choices, you can either hope the stock doesn't go up, or you can "buy back" the call, this would be a "buy to close" and thus take your risk off of the table. Knowing that you are inexperienced, I would buy back the call to close and be done with it (unless you own the underlying stock and are comfortable with your current overall position.
Call options go up in price when the stock goes up, and put options go up in price when the stock goes down. So call prices move in the same direction of the stock price, and put prices move in the opposite direction.
If you plan to do options, you either need to only do covered calls or possibly a put to hedge a stock position. Or if speculating a little, buy options because you can only lose the premium you paid. DO NOT sell/write naked options as you could lose your shirt easily.
You really need to do some research or read some books on options before doing this. And I would "paper trade" for a while until you understand better what you are doing. TD Ameritrade's ThinkorSwim (TOS) platform has a wonderful platform for options and you can paper trade.
I didn't even get into the Delta or other Greeks, or the implied volatility that is important to understand if you plan to trade options. These are important to know the correct strike and to maximize premiums. Options can be very valuable to create income or hedge, but are complicated instruments that you should understand. Assuming you were going to hold the stock anyway, you can't get hurt doing covered calls and really just limits your upside. But much more than that can be dangerous.
I know this was an awful lot, but you asked a complicated question and it was a little confusing. So I wanted to cover all of the bases and wanted to give you some basics with examples.
Hope this helps and best of luck, Dan Stewart CFA®