When sellers of call options begin covering their short positions -buying back the shares they sold at a loss it normally indicates upside for a stock because if the stock goes higher, against their bet, they can incur huge losses.
1. What are stock options?
Options give a buyer the right to buy or sell the underlying share for a predetermined price at a preset date. A call option confers the right, but not an obligation, on the buyer to pur chase underlier shares from the seller. For ex ample, if a call buyer buys a 100 option on ABC whose current market price is `90, and if the share price rises to, say , `105, the call buy er can buy the share for `100 and sell for 105, pocketing the differ ence of `5. Here, the seller is obliged to sell the share for `100 to the buyer even though the CMP is `105. As a result, the seller makes a `5 loss. In practice, only the difference is exchanged - meaning the delivery can be taken only at expiry . Before that, only cash settle ment happens.
2. How does one know that a stock could rise looking at the options data?
In the above example, let us as sume an interval of `5 between option levels. If at 105 and 110 and so on the open interest keeps falling as the price rises, that is an indication of short covering. Also, at such times, one might observe that sellers will sell put options on the same stock to pocket premiums in the belief that prices won't fall. Open interest is nothing but outstanding position in a share counter. For example, a seller's sell position is open so long as he does not reverse the transaction.
3. What are the chances of a stock falling and a seller losing?
A put-option holder gains when the underlying share falls. In such cases, the put seller loses money if the share falls below the option level sold plus premium received from buyer. As the option prices jump, open interest falls, indicating the seller is covering his short position.
4. What are the odds of a buyer making money in options ?
Options prices depend not just on un derlying stock price movement, called delta, but also momen tum or price rise or fall, called vega, and time to expiry called theta. All these determine an options price and therefore play on options is risky for buyers. Buyer, beware! It is said that an option seller wins 8 out of 10 times, at the cost of the buyer.
5. How does the seller gain?
He receives premium for selling puts or calls to a buyer. Premium is nothing but price paid by the buyer to give him the right to buy or sell an underlying share.
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