Writing Options for Premium

Get one distinction straight before this section, because “selling an option” means two opposite things and conflating them costs money. Every option order is one of four: buy to open (a new long), sell to close (exiting that long — if your call rose because the stock did, this is how you lock in the gain), sell to open (writing a new contract, which is what this section is about), and buy to close (covering a write). Selling to close a profitable long is just taking profit; selling to open is the premium-collection business: you are paid up front for taking on an obligation, and you profit from time decay and from volatility coming in lower than the price implied.

Options are often priced higher than the expected volatility of the underlying equity index, embedding a risk premium. This premium exists because option buyers transfer risk to option sellers. When you sell options, you effectively earn this risk premium, a process known as “selling volatility”. A short straddle position — selling both a call and a put at the same strike price — profits when actual volatility is lower than implied volatility, and loses when actual volatility exceeds it. This difference is termed the volatility risk premium.