Writing Calls and Puts

The uncovered call

An investor writes 1 XYZ October 50 call at 4 without owning XYZ.

Maximum gain: the premium, $400, realized if the stock stays at or below 50 and the call expires worthless.

Breakeven: strike plus premium, 54 — the same breakeven as the buyer's, because a zero-sum contract has one crossing point.

Maximum loss: unlimited. If assigned, the writer must deliver stock they do not own and must buy it at whatever the market demands. There is no ceiling on a stock price, so there is no floor under the loss.

This is the only genuinely unlimited-loss position the exam presents, and everything about how the industry treats uncovered writing follows from it. Cboe Rule 9.1(f) requires a firm doing public business in uncovered options to maintain written procedures covering the criteria for judging a customer suitable for uncovered writing, approval of such accounts in writing by a Registered Options Principal, designation of a specific principal responsible for approving accounts that fall outside the firm's stated criteria, minimum net equity requirements, and delivery to the customer of a special written description of the risks of uncovered writing before the first such transaction.

So when a question describes a modest retail customer wanting to write uncovered calls for income, the answer is not about the arithmetic. It is that the strategy is unsuitable and the account would not be approved for it.

The covered call

The same short call written against 100 shares of the underlying is an entirely different position, because the assignment risk is satisfied out of stock already owned.

An investor buys XYZ at 48 and writes 1 XYZ October 50 call at 4.

Maximum gain: the appreciation to the strike plus the premium. The stock can be called away at 50, giving 2 of appreciation, plus the 4 premium, so 6 per share, or $600.

Maximum loss: the stock can fall to zero. The investor paid 48 and received 4, so the loss is 44 per share, or $4,400. Note it is not unlimited — but it is large, and it is the stock's risk, not the option's.

Breakeven: the stock cost minus the premium, 44. The premium provides a cushion of exactly its own size, no more.

The objectives a covered call writer is pursuing: additional income from a holding, and a partial hedge against a modest decline. What they are giving up is the upside above the strike. That trade-off defines suitability — a customer who is strongly bullish should not write covered calls, because they are selling the outcome they expect.

A covered call is the conservative option strategy, and it is the one an income-oriented customer with an existing long position is most often steered toward. Note the specific meaning of covered: the writer holds the underlying, or holds a long call at the same or lower strike with at least as long a term, or has deposited an escrow receipt. Holding a convertible security convertible into the underlying can also cover.

Writing puts

An investor writes 1 XYZ October 50 put at 3.

Maximum gain: the premium, $300, if the stock stays at or above 50.

Breakeven: strike minus premium, 47.

Maximum loss: strike minus premium, 47 per share or $4,700 — the same bounded figure as the long put's maximum gain, for the same reason: the stock stops at zero. An uncovered put's loss is large but not unlimited, and a question that answers 'unlimited' for a short put is wrong.

A short put is a bullish-to-neutral position. The writer profits when the stock stays up and is obliged to buy at the strike when it falls. Two legitimate uses. First, income from a stock the writer is content to own: cash-secured put writing amounts to being paid to place a limit order below the market, and if assigned, the effective purchase price is the strike less the premium. Second, a bet that a stock has bottomed.

A covered put — writing a put while short the underlying stock — is the mirror of the covered call and is far less common. The short stock position covers the obligation to buy. The exam mentions it mainly to test whether you know that the premium's cushion works in the opposite direction.

One exam habit worth building: for any short option position, first ask whether the risk is bounded. Short call uncovered, unbounded. Short call covered, bounded by the stock's own downside. Short put, bounded by the strike less the premium. Getting that classification right answers a large fraction of the questions before any arithmetic.

Assignment, and what the writer can and cannot control

Assignment is not a decision the writer makes. When a holder exercises, the OCC assigns at random to a clearing member firm with a short position in the series, and the firm allocates to a customer at random or by first-in, first-out under a disclosed method.

Three consequences follow.

A writer cannot prevent assignment. The only escape is a closing purchase before the assignment notice arrives, and once assigned the transaction stands.

Early assignment happens, and it happens most often when an option is deep in the money and, for calls, just before an ex-dividend date — because the call holder who exercises early captures the dividend that the option's terms will not adjust for. A covered call writer whose stock is called away just before the ex-date has lost the dividend they expected, which is a real and common surprise.

An in-the-money option left to expire will generally be exercised automatically by the OCC under its exercise-by-exception procedures, so a writer who assumes an in-the-money short position will simply expire is mistaken.

A final note on income framing. Both covered call writing and cash-secured put writing are commonly sold to customers as income strategies, and both genuinely produce premium income. What must also be disclosed is the cost: the covered call writer has capped their upside, and the put writer has committed to buy a falling stock. A recommendation that presents the premium without the obligation is incomplete, and Regulation Best Interest reaches exactly that omission.