Selling calls on calls?

Someone sent me an e-mail today, linking me to an interesting question on /r/wallstreetbets. Here it is:

The answer to that question is that you are indeed allowed to sell calls on your calls. Before we go on, let us sum this (rather advanced) situation. Given a certain stock that we will call ABC inc.

1-If you sell a call, you give someone the right to buy 100 shares of ABC inc. from you. This right expires (lapses) eventually.

2-If you sell a call on the call described in 1, then you give someone the right to buy the right to buy 100 shares of ABC inc. from you.

That’s it. It’s no more complicated than one. This product, called a calloncall, would be interpreted as follows:

“In the next X days, you can buy a call that will be valid for Y days, where Y>X”

There are also callonputs, putoncalls and putonputs. Buying a putonput, for instance, would mean that you are buying the right to buy the right to sell 100 shares of ABC inc. at a given price, for a given period of time.

Sounds complex? Well, it is. These products are difficult to price and can be very risky. If you understand the idea behind options is leverage, then you understand options on options are extra leveraged.

Now, the question is: can a normal person trade them? The answer is no. These products are not even traded OTC (over the counter), which means there is basically no interest for them. Many regular options have very little volume, or no volume at all, so you can understand why options on options are traded even more rarely.

If you want to deal with options on options, then you will have to do so on a case by case basis. Typically, this means having lawyers set up everything, writing a contract, etc. You would most likely enter this contract with a large bank or some other large fund. Obviously, these people are not interested in dealing with you and they are not interested in dealing with small amounts. The financial crisis made them even more risk-adverse and very few, if any, professional risk managers are interested in options on options, just because they are so rare. In 20 years working in finance, I have not even seen them being traded once.

So the answer to that question is that, yes, you can sell a call on your call in theory, but in practice, forget it.

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