What is crushing
The crush involves the sale of options that are considered to be overvalued or undervalued, with the assumption that the options will not be exercised. Crushing is a speculative strategy that some option subscribers can use to collect a premium even when they believe that the underlying security is mispriced. Investors can also describe the strategy as “dominant”.
The author / seller of an option has the obligation to deliver his shares to the buyer if the buyer decides to exercise the option, while the holder / buyer of an option has the right but not the obligation to buy the seller’s shares at a determined price within a specified period. Overwriting is a technique used by speculative option writers in order to take advantage of the premiums paid by option buyers for option contracts that the writer hopes to expire without being exercised. Overwriting is considered risky and should only be attempted by investors who have a thorough understanding of options and option strategies. (For more reading, see: The ins and outs of put options.)
Why overwrite is used
Crushing can help investors who hold a dividend paying stock increase their income by collecting the premium they receive from purchasing an option on the stock they hold. For example, if they currently receive a 3% dividend yield, they could increase that yield to more than 10% by overwriting. The strategy works best when stock prices have fallen sharply and premiums are overvalued, as higher premiums help to offset any additional losses. (For more information on bonuses, see: Become familiar with Premium options.)
Example of overwriting
Suppose an investor holds a stock that trades at $ 50. He decides to write a $ 60 call option against her which expires in three months and he receives a $ 5 bonus. The buyer will likely exercise his call option if the stock trades above $ 60 before the expiration date, which limits the seller’s profit to $ 15 per share (the difference between $ 50 and $ 60 , plus the premium of $ 5) on an asset that can continue to increase. value. This is why the seller hopes that the call option will expire worthless – he will be able to keep the premium he has already received AND he continues to hold an increasing asset. If the inventory decreases, the $ 5 premium that the seller has received partially compensates for any loss suffered.
The downside risk is that if the stock price rises sharply, the seller will lose any profit he would have made above the exercise price of the options. To combat this, the seller may want to buy the option, although he should most likely buy it at a higher price than the one for which he sold it.