When it comes to options trading, one of the most important concepts to understand is the premium. The premium is the price that a buyer pays for the right to buy or sell an underlying asset at a specific price, known as the strike price. But what happens to the premium when you sell an option?
First, let’s review the basics of options trading. There are two types of options: calls and puts. A call option gives the buyer the right to buy an underlying asset at the strike price, while a put option gives the buyer the right to sell an underlying asset at the strike price. The seller of an option, also known as the writer, receives the premium from the buyer in exchange for taking on the obligation to sell or buy the underlying asset if the buyer chooses to exercise their option.
Now, let’s consider what happens when you sell an option. If you are the writer of a call option, you receive the premium from the buyer and are obligated to sell the underlying asset at the strike price if the buyer chooses to exercise their option. If the price of the underlying asset remains below the strike price, the buyer will not exercise their option and you get to keep the premium as profit. However, if the price of the underlying asset rises above the strike price, the buyer may exercise their option and you will be obligated to sell the underlying asset at a loss.
On the other hand, if you are the writer of a put option, you receive the premium from the buyer and are obligated to buy the underlying asset at the strike price if the buyer chooses to exercise their option. If the price of the underlying asset remains above the strike price, the buyer will not exercise their option and you get to keep the premium as profit. However, if the price of the underlying asset falls below the strike price, the buyer may exercise their option and you will be obligated to buy the underlying asset at a loss.
In summary, when you sell an option, you receive the premium from the buyer and take on the obligation to sell or buy the underlying asset if the buyer chooses to exercise their option. The premium you receive is your profit if the buyer does not exercise their option, but you may incur a loss if the buyer does exercise their option.
