A put option which is sometimes simply call as put is a name given to a financial contract between two parties, the seller (writer) and the buyer of the option. a short position has been acquired by the buyer and it is there right, but not obligation, to sell the underlying instrument at an agreed-upon price (the strike price). If the right has been exercised by the buyer that is granted by the option then the seller has the obligation that he has to purchase the underlying at the strike price. For having this option, fees (the option premium) has been paid by the buyer to the writer. The terms for exercise differ and that depends on option style.
The holder is allowed by the European put option that he can exercise the put option for a short period of time right before expiration, while by an American put option the holder is allowed to exercise at any time before expiration.
The put options that are most widely-traded are the put options on equities. However, there are many other instruments on which options are traded such as interest rates or commodities.
It’s likely believed by the put buyer that either the price of the underlying asset will fall by the exercise date, or he hopes to protect a long position in the asset. The advantage that a trader will get by buying a put over short selling the asset is that the risk is limited to the premium. For a put buyer,the profit is limited to the strike price less the underlying’s spot price (in addition to the premium already paid).
It is not believed by the put writer that the price of the underlying security is likely to fall. In order to collect the premium the writer sells the put. For the put writer,the total loss is limited to the strike price less the spot and premium already received. In order to limit portfolio risk puts can be used, and they may be part of an option spread.
Naked Put Or Uncovered Put
A put option where the option writer (i.e., the seller) does not have a position in the underlying stock or other instrument then the put option is referred to as a naked put (also known as an uncovered put). This strategy is best used by those investors who are willing to accumulate a position in the underlying stock but only in case if the price is low enough. If the investor fails to buy the shares, then the option premium is kept as a ‘gift’ by him for playing the game.
The option owner can exercise the put option and force the writer to buy the underlying stock at the strike price, if the market price of the underlying stock is below the strike price of the option when expiration arrives. By this the exerciser is allowed to get some profit from the difference between the market price of the stock and the option’s strike price. But if in case when expiration day arrives the market price is above the strike price , then the option expires worthless and the writer gains profits by keeping the premium collected when selling the option.
There can be a substantial potential loss on a naked put. If in case, the stock falls all the way to zero (bankruptcy) then the loss is equal to the strike price minus the premium received. The premium received at the time of selling the option is the potential upside. If during the option’s lifetime, the stock moves lower, then there may be an increase in option premium (that depends on how far the stock falls and how much time passes), and it becomes more costly to close (repurchase the put sold earlier) the position that will result in a loss. If before the put position is closed,the stock price completely collapses, then the put writer can face potentially catastrophic losses.
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Posted by R. MAK. in Currency Rates, Currency Trade, Forex Basics, Forex Facts, Forex Market, Forex trading, Trading · 0 Comment
