Covered and uncovered sale
Any option sale can be:
1. Covered- sold in us option and there is long position in the underlying asset in case Sales Call or short position in the underlying asset in case Put sales. The position in the underlying asset covers your risks on the sold option.
When you sell a Call option, the growth of the market brings you a loss on the option, but a long position in futures will give profit in this case and, thus, covers your risks when selling an option.
A similar situation arises when selling a Put option. When the market goes down, our option becomes more expensive and brings us a loss, but a short position in the futures is profitable and also covers the risk when the option is sold.
2. The topic of today's lesson is the so-called uncovered sale of options. We just sold a Call or Put option, and there is no position in the underlying asset, which covers us the risk of our option.
Risk / reward ratio
In this case, as we already know from past classes, profitoption sellers limited by the option premium, and potential riskin theory - not limited.
The realization of this risk can lead to serious negative consequences., up to the loss of a trading account.
In history, as a world, and the Russian derivatives market, there have already been many cases, when even serious financial institutions suffered large losses or even went bankrupt as a result of selling uncovered options.
The most famous cases:
1. English Barings Bank (1995 year – bankruptcy as a result of trader abuse and huge losses on sold options on the Japanese Nikkei index)
2. French Societe Generale (2007 a year - a loss of several billion euros)
3. Russian Kit Finance (2008 year - the sale of a large number of Put options on the RTS index just before the collapse of the market this fall - a loss of about $500 million, sale of a bank and change of owners)
Such a significant risk, arising from the sale of uncovered options, scares off newbies, but most experienced option traders, against, Believe, what the most stable way of making a profit on the market is based on selling, not buying options.
The secret is, that they understand the risks of working from the sale and are able to competently neutralize these risks.
Before, how we move on to the risks of these strategies, we will consider in the next lessons profit / loss profiles simple positions from sale, namely sold Call and Put options.
