Can I short sell call options?

Options and Warrants: An Overview

Options are very similar to warrants, but they differ in a few ways. The main difference is that options are not issued by banks.

As a private investor, you can assume the role of issuer of options by selling options “short”.

A short sale is the sale of a security or subscription right without having it in the custody account. The short sale of options, a so-called “option writer”, is almost completely unknown to private investors in Germany.

Instead, you as an investor are showered daily with advertising for new certificates and warrants from the banks. The writer business in the USA, the home of stock trading, is familiar to almost every investor.

Options: advantages

  • No issuer benefits from the options business. That makes them cheaper for you.
  • Options are not subject to the arbitrariness of an issuer. With warrants, you sometimes have to accept unfair price determinations or a temporary suspension of prices. Because the issuer tries to protect itself from unfavorable price positions.
  • Options give you greater freedom of action. In this way, you can take on the role of the issuer and act as a writer (you will find an explanation on the next page).
  • With options, there is no risk that the issuer will become insolvent. However, you bear this risk when purchasing warrants.

Options: disadvantages

  • Trading options at most banks is far more expensive than trading warrants.
  • Options are traded in contracts with a predetermined number of pieces, so that you can only buy them in packages and thus more money.

Option transactions: thanks to options also possible for private investors

Options are very similar to warrants, but they differ in a few ways.

The main difference is that options are not issued by banks. As a private investor, you can assume the role of issuer of options by selling options “short”.

A short sale is the sale of a security or subscription right without having it in the custody account. The short sale of options, a so-called "option writer", is almost completely unknown in Germany.

Instead, you as an investor are showered daily with advertising for new certificates and warrants from the banks. The writer business in the USA, the home of stock trading, is familiar to almost every investor.

Covered and uncovered writer transactions

With a writer transaction, you can differentiate between a covered and an uncovered writer transaction. In general, the following applies: In the case of a covered option writer, the option writer can service the sold options with positions from his portfolio.

A writer who has the shares on which he sells calls in his custody account is thus doing a covered writer transaction. In the case of an uncovered writer transaction, he does not have these shares in his custody account.

In this post I will only explain covered writer business to you. In principle, I advise you against the very risky uncovered option writers. With these, your risk is basically unlimited.

Warrants: banks as writers

Warrants are good business for the issuer. Because the statistics are massively on the bank's side: an average of 75% of all warrants expire

worthless, and the bank can keep the money received from the buyer.

But banks don't just make money on warrants that expire worthless. In many cases, they own positions in the stocks on which they issue warrants. They take on the (highly lucrative) role of a covered writer.

Here is an example: A bank owns shares in Daimler (current price € 52.80) and issues a call warrant on them at a price of € 1.50 and a base price of € 56.

This call gives the buyer the right to buy the share for € 56. This is of course only worthwhile for them if the share price is quoted above the base price at the end of the term. Otherwise, the warrant is worthless on the due date and the issuer is doing good business.

When the warrant is sold with the relevant shares in its own custody account, it is nothing more than a covered writer transaction in which the bank is in a comfortable position, as you will see below.

Warrants: The Expiration Date

Let's take a look at what happens from the bank's point of view on the expiry date of the warrant. There are 4 basic scenarios possible.

Case 1: At the end of the term, the Daimler share is exactly at its level at the start of the term. The warrant expires worthless. This means that a premium of € 1.50 is forfeited per share. The bank has thus generated a return of + 2.8%, although the share has not moved.

Case 2: The Daimler share is quoted below the initial price of € 52.80, for example at € 50.00. Then the bank definitely has a loss in the share (here € 2.80). However, this is reduced by the profit in the sold warrant of € 1.50.

Because the warrant will of course not be exercised. Purchasing the share on the stock exchange is cheaper for the warrant buyer than purchasing € 56.00 by exercising the call.

In this case, the bank makes a loss, but it is less than with a direct investment in the share.

Case 3: The Daimler share is quoted at exactly € 56.00, the base price of the warrant. Here, too, the warrant expires worthless. In the share alone, the bank has made + 6.1% profit since the start of the term. In addition there is + 2.8% from the sale of the warrant.

That makes a total profit of + 8.9%. That is the maximum profit that the bank can achieve with this construction.

Case 4: The Daimler share is quoted well above the base price, for example at € 60.00. The bank then has a profit of € 7.20 on the share, but the warrant sold is now worth € 4.00.

Because it entitles the holder to buy the share at € 56.00, which is € 4.00 cheaper than the market price of € 60.00.

This results in the following calculation for the bank: Profit in the share: € 7.20, loss in the warrant sold = € 4.00 (value on the settlement day) € 1.50 (purchase price received for the warrant) = € 2.50. The total profit for the bank is € 7.20 - € 2.50 = € 4.70 = 8.9%.

As you can see, in 3 out of 4 cases the bank is cheaper by selling the warrant than if it were only invested in the shares. The (covered) “standing still” promises the bank an excellent risk / reward ratio.

As an investor, you can take on a similar advantageous position as the bank in this example. However, you are not selling a warrant, but an option. The trading platform for this is EUREX. Not to be confused with the EUWAX warrant exchange.

On the EUREX homepage under “Training” you will find learning clips and e-seminars to strengthen your knowledge in business with options and everything that goes with them.

It's not as difficult as it might sound at first.

Friday is the big day of expiry on the stock exchanges. Tomorrow, for the first time this year, witches dance on the stock exchanges. What I mean by that and what significance this drama has for you, you can read in this post. > read more


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