Options: Long vs Short Position and Why It Matters

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• Options are financial derivatives typically used for speculative day trading, portfolio hedging and potential short-term profits - they are often highly leveraged and are not suitable for long-term investments.
• Options give you a choice to buy or sell the underlying asset (e.g. a share) at a stated price, called the strike price, before or on a predetermined date.
• An options contract gives the buyer the right to either buy or sell the underlying asset at the strike price, but not both. Which right is given is dependent on the type of option in the contract.

Long Position (Buyer of an Option) vs Short Position (Seller or “Writer” of an Option)

Instead of buying an option, you can sell it. The decision of whether to exercise the option or not will still be with the buyer and not you as the seller. Hence, if you should take up the position of a seller, you will have no say in the matter.

Long Position: you have bought the call or put option from another party. You are known as the buyer.

Short Position: you have sold the call or put option to another party. You are known as the seller or the writer.

Your payoff and profit will be the direct opposite of your counterparty. In other words, your payoff as the writer of the option can never exceed $0 and will always be negative or 0. Because of the premium you received at the start from the buyer, your profit can be positive.

It is extremely important to note that unlike when you buy an option, when your loss is limited to the amount that you paid as premium and the profit is unlimited, when you are the writer of an option, your profit is limited to the amount that you received as premium and the loss is unlimited for call options.

Visualising Payoffs and Profit

Let’s use this example:

• A put option with the underlying asset being 100 shares in Apple.
• Bought on 1st December for a premium of $80, when the share price of Apple is $4.50 ($80 total for an option contract of 100 options).
• The predetermined date stated in the call option contract is 31st December.
• The strike price stated in the call option contract is $5 per share.

We will take the perspective of the seller.

OPTIONS 101: LONG vs SHORT POSITION. COMPLETED. ✅

Sources:

1. https://www.ig.com/sg/options-trading/what-are-options-how-do-you-trade-them
2. https://www.investopedia.com/terms/o/option.asp
3. Header photo by Pixabay