I can sell call options 10% out of the money each week and make some nice cash. If my plan was to hold the stock long term, there's no downside risk because if the stock goes down, I get to keep the cash (premium) from selling the calls. If it goes sideways or slightly up I get to keep it as well.
The only "downside" is it goes up >10% in which case i've made that 10% + premium, but I've now had my stock taken away from me.
In this case, I lose out on an additional 10% in upside because it went up 20% overnight.
Loss aversion and all that, but it feels like a reasonable strategy where you still come out ahead in the worst case. In the typical case, you can continue to collect those pennies.
Top notch comment, considering options trading is often described as "picking up pennies in front of a steamroller."
> Loss aversion and all that, but it feels like a reasonable strategy where you still come out ahead in the worst case
You don't come out ahead in the worst case – your option can be exercised and you are compelled to sell a stock at a loss. Worst case you could lose a major chunk of change.
But you were offering it based on the market price when you offered it. The "loss" is merely one of opportunity, you're not actually losing any value you had when you sold the option, right?
On the other hand, if the price shoots up to, say, $85, I'm still obligated to sell them at $50. Since I bought them at $10, I've still made $4001 profit, but I'm still dissatisfied because I would have made $7500 if I hadn't sold the call option.
What you're describing is what happens if I don't already own those shares and the price skyrockets. If the counterparty exercises their $50 option when the current price is $85, then yes, I'm obligated to buy the shares at market price and sell for a total loss of ($STRIKE_PRICE * 100) - $5000 - 1.
If I write a covered call which is assigned as you detailed above, I've sold an asset worth $8500 for $5001 against a cost basis of $1000. I've booked a capital loss of $2499. That's not "dissatisfaction", that's GAAP. You, the IRS, and pub 550 can figure out if it's a short term or long term loss and what to do next.
I'm trying to understand why a counterparty would enter into an arrangement where a stock price change obligates them to financial liability like this. Presumably there's some upside if the stock price goes the other way, but it's unclear who the $ would come from in that case.
Also: Who originates options? When someone buys an option, is it the brokerage who collects the fees? Is the counterparty already involved at that point?