Options – stable income with unlimited risk

This subheading sounds ridiculous, doesn’t it? How can stable income go hand in hand with unlimited risk?

To understand it, let’s first understand what an option is and how it’s possible to trade them.

An option is a derivative (see Chapter 1, Developing Trading Strategies – Why They Are Different, for a brief explanation of the underlying and derivatives) that gives its holder the right but not the obligation to buy or sell the underlying asset at a certain price in the future.

I know that it’s really hard to understand at first, so let’s consider an example. Say, it’s October and a kilo of apples costs $1 at the moment. I think that its price will grow to $2 by December, but another market participant thinks that even if it grows, it won’t exceed $1.5. So, this market participant writes an option to buy apples at $1.5 in December and sells this option to me for a premium...