At this point, you might well ask, who sells the options that option buyers purchase? The answer is that options are sold by other market participants known as option writers, or grantors. Their sole reason for writing options is to earn the premium paid by the option buyer. If the option expires without being exercised (which is what the option writer hopes will happen), the writer retains the full amount of the premium.
It should be emphasized and clearly recognized, however, that unlike an option buyer who has a limited risk (the loss of the option premium), the writer of an option has unlimited risk. His loss, except to the extent offset by the premium received when the option was written, will be whatever amount the option is “in-the-money” at the time of expiration. Simply said, any profit realized by an option buyer represents a loss for the option seller. And, it’s worth saying again, there is no limit on how large this loss can be!
The foregoing is, at most, a brief and incomplete discussion of a complex topic. Options trading has its own vocabulary and its own arithmetic. If you wish to consider trading in options on futures contracts, you should discuss the possibility with your broker and read and thoroughly understand the risk disclosure statement which he is required to provide. In addition, have your broker provide you with educational and other literature prepared by the exchanges on which options are traded. Or contact the exchange directly. A number of excellent publications are available, including Options on Futures Contracts: An Introduction, which can be obtained by calling NFA’s Information Center toll-free at (800) 621-3570 or by visiting NFA’s web site at www.nfa.futures.org
Reprinted with permission from the National Futures Association. Copyright 2002.