All investment strategies carry risk, and transactions in options may carry a high degree of risk. Options derive their value from underlying equities or indices, and the derivative value is directly related to the underlying security, thus they carry many, if not more, of the same risks as the underlying equity or index. Sellers of options should familiarize themselves with the type of option (i.e. put or call) which they contemplate trading and the associated risks. You should calculate the extent to which the value of the options must increase for your position to become profitable, taking into account the premium and all transaction costs. Selling (“writing”) an option generally entails greater risk than purchasing options. Although the premium received by the seller is fixed, the seller may sustain a loss well in excess of that amount. The seller will be liable for additional margin to maintain the position if the market moves unfavorably. The seller will also be exposed to the risk of the purchaser exercising the option and the seller will be obligated to either settle the option in cash or to acquire or deliver the underlying interest. If the position is “covered” by the seller holding a corresponding position in the underlying interest or another option, the risk may be reduced. If the option is not covered, the risk of loss can be as much as the strike price, multiplied by the number of contracts, plus the trading cost, and minus the premium received. The purchaser is still subject to the risk of losing the premium and transaction costs. When the option is exercised or expires, the purchaser is responsible for any unpaid premium outstanding at that time. The risk of uncovered put positions is substantial. The writer of an uncovered put option bears the risk of loss if the underlying security declines below the strike price. The loss could be substantial if there is a significant decline in the value of the underlying security. Uncovered option writing is suitable only for knowledgeable investors who understands the risk, has the financial capacity and willingness to incur potential losses, and has sufficient liquid assets to meet applicable margin requirements. In this regard, if the value of the underlying instrument moves against an uncovered writer’s position, the broker may request additional margin collateral. Or if the collateral loses significant value and is not able to support the margin requirement, the broker may liquidate stock or options positions with little or no notice in accordance with the investor’s margin agreement.
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