What Do I Do If the Price of the Stock That I Sold an Option on Goes Above the Strike Price?
Options writers who own stock give buyers the right to exchange their options for stock if the share price reaches a certain point, called the strike price. An option is a contract that allows a buyer to purchase an asset at a certain price at a specific time. If an options writer writes a "call option," he bets that the stock will decrease in value. If the stock increases in value and goes above the stock price, he should usually take action to avoid substantial losses.
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Buying
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Writers can choose to buy back their written call option, which closes out their position at a loss. They prefer this method if they expect the stock to rise significantly in price, which can occur because of positive news about a company, favorable financial reports or investor sentiment. They can place a stop-loss order with their brokerage to automatically close out their position when the option's value reaches a certain point above the strike price.
Hedging
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Options writers who anticipate a drop in the stock price before the option expires should not buy back their option at a loss. They can instead sell short a "put option." If the stock continues to go up in price, the loss from the written call option will balance out the increase in value from the sale of the put option. If the stock price begins to drop, they can cover their put option and increase their profits.
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Holding
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Writers who issue covered call options may choose not to buy back or hedge options contracts, because most options contracts expire worthless. Options contracts consist of time value and intrinsic value. Time value exponentially decays over the life of the option until it reaches zero, while intrinsic value represents the amount the option has increased because of reaching or surpassing the strike price. When an strike price hovers slightly above the stock price, an options writer can turn a healthy profit because of time value decay by not closing out his position.
Warning
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Writers who sell a "naked call option," a situation where they don't own the stock they wrote an option on, should take immediate action to secure their position, because they can suffer an unlimited loss. Writers with a large loss on a call option will face a margin call by their broker, which will force them to liquidate their position at a significant loss, and they may even owe money to their brokerage.
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