Question

2. Knowing that option sellers have limited gain and unlimited loss, why there are many option writers willing to sell options?

Answer 1

Unlimited loss is only on paper. A stock price can go up to any value in theory, but practically this is not possible. On the down side, the stock price can go down to zero. So, the loss is limited to the price of the stock on the down side.

Limited gain is only one side of the equation. Many would forget the other side of the equation - the probability of profit. Many option writers sell options for the very same reason. Limited profit but a very high probability of success.

Example: Currently the stock is trading at $100

One month expiry $110 strike call option is selling for $1

The call option seller would make a limited gain of only $1 per share or $100 per contract if the stock price stays below $110 by expiration date in month.

The stock price can go down, or stay at $100 or go up to $110. In all these three cases the option seller makes a profit.

Yes, there is unlimited loss if the stock price goes above $110 by expiry. But, what is the probability of that happening? Very low!

A stock moving 10% in one month is very low. For the buyer of the call option to make even one dollar the stock price has to go to $112 by expiry. That is 12% in one month! Very rarely does this happen.

So, option writing has a higher probability of success than option buying and for this reason many option writers are willing to sell options.