Question

1. Knowing that option sellers have limited gain and unlimited loss, why there are many option writers willing to sell options? (6marks)

Answer 1

Option sellers are willing to sell options even though they know that they have limited gain and unlimited loss because they always know that there are various out of the money options which are having a probability of lower execution because they can never be achieved in the maturity period, so they will be trying to sell upon those options and they will be trying to eat the premium because they feel that the prices of these options are going to go worthless and hence there is a very low probability of achievability of these strike prices.

option sellers are always playing with the very high probability of gaining and very low probability of losing and they are also having their exposure through covered positions so they are trying to take the position in the derivatives market in order to eat the premium and they are also trying to maximize rate of return so there is a very high probability of gaining a significant amount on out of the money options, whereas there is a very low probability on exercising the out of the money options and hence option sellers are continuously trying to involve themselves in order to make higher rate of return in market.