Who sold you the call

In the previous lesson you bought a call: the right to buy BTC at 90,000. You paid 1,000. Somebody received that money. That is the seller of the call.

Who he is. A market participant like you: a trader or a professional market maker. On the exchange the call has its own order book, like a coin. The seller placed an order in it: “selling a 90,000 call for 1,000”. You pressed “buy” — a trade.

What he sold. A promise: “if in a month the price is above 90,000, I will pay the difference”.

• He never bought this call anywhere. A promise is made from scratch. It is the same as shorting futures: you sell a contract you never had.
• To back the promise the exchange locks margin on his account. Not the whole 90,000, about 10,000 — the next step covers it.
• The 1,000 is his payment for the promise. That is why only the buyer pays the premium.

• What one of them won, the other lost.
• Your loss is at most 1,000. His gain is at most 1,000.
• Your gain is unlimited. So is his loss.

The margin is not the whole amount. The call seller does not need to hold 90,000. The exchange locks a part, as on leveraged futures.

• On Deribit it is 10–15% of the coin price plus the price of the option itself.
• In our example — about 10,000 dollars.
• The price moves towards the strike — the exchange demands more. Not enough margin — the position is liquidated.

The risk is the same as a short’s. “Unlimited” sounds scary, but you already know this risk: every futures short has it. Compare at the same prices: a short of 1 BTC from 86,000 and a 90,000 call sold for 1,000.

• On a rise the call seller is always 5,000 better off than the shorter: 4,000 of room to the strike and 1,000 of premium.
• On a fall the shorter earns more and more, while the call seller earns only his 1,000.
• The call seller is a shorter who gave up the gain on a fall in exchange for 1,000 now and some room on a rise.

There are no liquidations in the table: it assumes the margin was enough. Without spare funds on the account both get liquidated.

Getting 1,000 on 10,000 of margin while risking 4,000, 9,000 and more still looks like a bad deal. But the seller counts not one trade but many in a row.

For him to pay, the price has to rise from 86,000 to above 90,000 within a month. That does not happen every month. In our example — one month out of four.

Four months in a row: BTC is at 86,000, the seller sells a 90,000 call for 1,000, you buy it.

• The seller has a small gain often and a big loss rarely. The buyer has the opposite.
• In total both are at zero. The premium is the price at which one side’s risk and the other side’s chance balance out.
• Who ends up ahead is decided by the market. Calmer than expected — the seller wins. Wilder — the buyer.

That is how an insurance company works: it takes a small fee from every house and knows that few of them burn.

The higher the risk, the more expensive the promise. In a nervous market the same call costs 1,900 instead of 1,000. The OPTIONS IV indicator shows this.