Put Options

12 Key excerpts on "Put Options"

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  eBook - ePub

  The Options Edge

  An Intuitive Approach to Generating Consistent Profits for the Novice to the Experienced Practitioner

  • Michael C. Khouw, Mark W. Guthner(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  expiration date. If the buyer of an option chooses not to exercise this right during the life of an option, it simply ceases to exist, and both parties go their merry way.

  There are two basic types of options, puts and calls. The type of option the investors select to use is dependent on their investment goals and risk management objectives. Since there are millions of investors employing different strategies trading options, both types are actively traded in the financial markets every day. A call option is a bullish instrument. It gives the buyer the right, but not the obligation, to purchase the underlying instrument at a predetermined price. Investors buy call options with the expectation that the price of the underlying security will rise. The seller of a call does so with the expectation that the price of the underlying instrument will stagnate or fall. Investors might buy a call to manage risk as well. Investors who hold a short position on the underlying instrument, with the expectation the price of that asset will fall, are at risk the price will spike higher. Buying a call allows short sellers to limit their risk by allowing them to buy back their short position at a predefined price. A put option is a bearish instrument. It gives the buyer the right, but not the obligation, to sell the underlying instrument at a predefined price. Investors buy Put Options with the expectation that the price of the underlying instrument will fall. Like calls, puts can be used for hedging as well. If you are long the underlying stock, you might purchase a put option to limit losses should the price of that stock fall.

  How Options Are Created, Extinguished, and Settled

  Companies issue a fixed amount of stock, and those shares typically trade on an exchange. While options trade on exchanges much the same way stocks do, there is not a fixed amount of options outstanding. Options differ from stock in that they are created and destroyed as investors take positions during the normal course of trading. If Investor A wants to buy a call option on company XYZ, he instructs his broker to go to the exchange and find someone who wants to sell the same option. If he finds another investor or market maker, call her Investor B, who wants to sell that call with the same terms, and the two parties agree on a price, then a transaction takes place. Since Investor A does not own an option, he will “buy to open” a new position. If Investor B already owns the option she wants to sell, she will sell to close her current holding. In this process, an option is created and one is destroyed, and the total number of options outstanding does not change. If, on the other hand, there are no options outstanding or existing owners of the options do not want to sell, all is not lost. The broker finds a third party or market maker—call him Investor C, who wants to sell a call option he does not already own. Investor C writes a call option that does not currently exist and sells it to Investor A. Since Investor C does not own the option and is creating a new one, he sells to open

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  eBook - ePub

  Financial Markets for Commodities

  • Joel Priolon(Author)
  • 2018(Publication Date)
  • Wiley-ISTE

    (Publisher)

  5 Options Markets

  Options have seen considerable growth since the 1970s and, today, are among the most widely exchanged financial contracts on markets around the world. The basic principles on which options are based are easy to understand. However, the pricing of options is a difficult exercise based on an advanced mathematical corpus. This is why certain technical developments related to this are dicsussed in the Appendix.

  5.1. The fundamental concepts

  An option is a financial contract that binds the issuer, or writer of the option and the holder of the option, who has acquired the buying rights (option to buy) or the selling rights (option to sell) for certain goods, at a certain date (or over a certain period), at a price fixed in advance. In other words, the holder of an option has the right to buy or sell but has no obligation to exercise this right. When the contract is created, the option writer receives a premium paid by their acquirer. At the time when they commit to an options contract, the role of the seller and the buyer are unambiguous; but, going forward, the buyer may cede their option without, however, becoming the writer. This is why, in the rest of this chapter and in order to remove certain ambiguities, we will talk of “the writer” and not of the “seller”. Similarly, we will talk of the “holder of the option”, rather than “the buyer”. However, the reader must be aware that in other essays and books, these operators are very often called simply “seller” or “buyer”.

  5.1.1. Characteristics of options and a glossary

  The vocabulary used when talking about options is quite particular. We have provided, below, a list of the most frequently used terms:

  • – call

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  eBook - ePub

  The Amazing Put

  The Overlooked Option and Low-Risk Strategies

  • Michael C. Thomsett(Author)
  • 2019(Publication Date)
  • De Gruyter

    (Publisher)

  2  Puts, the Other Options: The Overlooked Risk Hedge

  Most investors are optimists. They assume their stocks are going to rise in value, starting from the moment they invest. In fact, many people think of their basis price as the zero point of the investment, and prices are going to move upward from there. The reality—that the price you pay is part of a never-ending give and take between buyers and sellers—is that prices can move both up and down.

  For many, this presents a problem. What if the price does go down? Doesn’t that mean you lose money? No. With options, you can profit in any kind of market, whether stock prices rise or fall, and even when prices don’t move at all. Put-based strategies can limit losses, protect paper profits, and combine with other stock and option positions to create profits no matter what direction the market takes.

  With focus on strategies involving calls, the options market may easily ignore the potential for puts, both as speculative devices and for managing and hedging a long stock portfolio. When employed to hedge risk, puts enable you to maintain holdings even when markets are volatile to the downside. The alternative—selling off stock positions out of fear of further declines—leads to lost opportunities. The classic outcome—selling stock to avoid further losses only to miss the rebound—is probably the most common timing problem for investors. Puts can eliminate this market risk.

  The adage, “Buy low and sell high,” should contain a second part: “instead of the opposite.” The tendency is to buy into the market top in the belief that prices will continue rising indefinitely and sell into the bottom in fear or even panic that prices will continue their downward spiral. Puts are useful in both situations. Buying long puts at the market bottom can be done to take advantage of a rebound; it may also be done as a means for offsetting lost opportunities after selling stock.

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  eBook - ePub

  Investing and trading strategies X3

  Day Trading Strategies, Options Trading for Beginners, Swing and Day Trading

  • George Graham(Author)
  • 2023(Publication Date)
  • Youcanprint

    (Publisher)

  CHAPTER 1: 

  What is Options Trading?

  1. What Are Options?

  An option is a contract that gives the holder the right to sell or buy an asset at a set price (the strike price) within a given period (the term) but does not obligate the holder into doing so. The strike price may be lower or higher than the current asset price (market price).

  Like a bond or stock, an option is a tradable security. You can purchase or sell options to a foreign broker or trade them on an exchange within the United States. An option may give you the opportunity to leverage your cash, though it may be high risk because it eventually expires

  (expiration date). For stock options, each option contract represents 100 shares.

  1. The Options Trading Concept

  An instance of an option is if you want to buy a car/house, but for whatever reason, do not have immediate cash for it but will get the money next month. The item owner may agree to give you the option to purchase the house in a month for, let us say $250,000 if you pay $2,500 now for the option. Near the expiration of your option, the asset’s value may appreciate perhaps because of the discovery that the house is on a highly valued piece of land.

  You can now buy the asset at the agreed price and sell it for a profit. The asset's value may also depreciate perhaps when the house develops plumbing problems or other problems or, in the case of a vehicle, gets into an accident. If you decide not to buy the asset and let your purchase option expire, you lose your initial investment, the $2,500 you placed for the option.

  This is the general concept of how options trading happens; however, in reality, options trading is a lot more complex and involves more risks.

  1. Basic Option Trading Terminologies

  As you begin options trading, familiarizing yourself with commonly used terms is vital to your options trading success. Below are the most commonly used option trading terms:

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  eBook - ePub

  AARP Getting Started in Options

  • Michael C. Thomsett(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  When you buy a put, it is as though you are saying, “I am willing to pay the asked price to buy a contractual right. That right provides that I may sell 100 shares of the specified stock at the indicated price per share, at any time between my option purchase date and the specified deadline.” If the stock’s price falls below that level, you will be able to sell 100 shares above current market value. For example, let’s say that you buy a put option providing you with the right to sell 100 shares at $80 per share. Before the deadline, the stock’s market value falls to $70 per share. As the owner of a put, you have the right to sell 100 shares at the fixed price of $80, which is $10 per share above the current market value. You own the right but you are not obligated. For example, if your put granted you the right to sell 100 shares at $70 but the stock’s market price rose to $85 per share, you would not be required to sell at the fixed price. You could sell at the higher market price, which would be more profitable. The potential advantage to option buyers is found in the contractual rights that they acquire. These rights are central to the nature of options, and each option bought or sold is referred to as a contract. The Call Option A call is the right to buy 100 shares of stock at a fixed price per share, at any time between the purchase of the call and the specified future deadline. This time is limited. As a call buyer, you acquire the right, and as a call seller, you grant the right of the option to someone else. (See Figure 1.1.) Let’s walk through an illustration and apply both buying and selling as they relate to the call option. • Buyer of a call : When you buy a call, you hope that the stock will rise in value, because that will result in a corresponding increase in value for the call

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  eBook - PDF

  Basic Finance

  An Introduction to Financial Institutions, Investments, and Management

  • Herbert Mayo, , , (Authors)
  • 2018(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Any time premium that the options commanded prior to expiration must disappear, since the option can be worth only its intrinsic value. If the option is out of the money, the option has no value and expires. Puts and calls are created and sold by investors (writers) who are either naked or covered. Covered call writing occurs when the individual owns the underlying stock. If the individual does not own the stock and writes a call (is a naked writer), the in-dividual is exposed to substantial risk if the price of the stock rises. In addition to options on individual stocks, put and call options exist on indexes of stock prices. Stock index options permit individuals to take long and short posi-tions on the market without having to select individual stocks. These investors avoid the risk associated with individual securities. Options also exist on bonds and for-eign exchange, which grant individuals the right to buy and sell these assets instead of actually buying and selling the bonds or currencies. Summary Review Objectives Now that you have completed this chapter, you should be able to 1. Describe the features of put and call options (p. 501). 2. Differentiate an option’s market value, intrinsic value, and time premium (pp. 501–503). 3. Explain how options offer leverage (pp. 503–507). 4. Explain the relationship between the market price of a stock and the prices of put and call options (pp. 503–507 and 509–511). 5. Compare buying a stock and a call option (pp. 505–507). 6. Contrast naked and covered call option writing (pp. 507–509). 7. Identify the advantages associated with stock index options (pp. 511–512). No actual securities or ETFs are based on the VIX, but the CBOE has created VIX put and call options. These derivatives permit individuals and portfolio man-agers to take positions based on expected volatility. For example, anticipation of increased volatility argues for buying calls or selling puts.

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  eBook - ePub

  Finding #1 Stocks

  Screening, Backtesting and Time-Proven Strategies

  • Kevin Matras(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  In fact, for the last seven years in a row, the volume of options contracts traded has steadily increased, with 2009 setting an all-time high of 3.59 billion contracts. More and more people are now including options in their investments as a smart way to get ahead of the market.

  Most people know that options offer many advantages, not the least of which is a guaranteed limited risk when buying calls and puts. They also offer a great deal of leverage while using only a fraction of the money you would normally have to put up to get into the actual stocks themselves.

  But as we said at the top, one of the best advantages of options is flexibility: the ability to make money if a stock goes up, down, or sideways, as well as to simultaneously provide ways to reduce your risk and increase your returns.

  Before we go over some of the different strategies, let me first go over a few definitions.

  Call Option: A call option gives the buyer the right (but not the obligation) to buy a stock (typically 100 shares) at a certain price within a set period of time.

  Put Option: A put option gives the buyer the right (but not the obligation) to sell a stock (100 shares) at a certain price within a set period of time.

  Premium: The amount paid (if buying) or collected (if writing) for the option.

  Strike Price: The price on an option contract at which you can exercise your right to buy or sell the stock.

  In-the-Money (ITM): For a call option, an in-the-money option is a strike price below the current price of the stock. It’s said to be in-the-money because it has intrinsic value.

  If a stock was trading at $50 a share, a call option with a strike price of $45 would be in-the-money. For a put option, it’s a strike price above the current price of the stock. If a stock was trading at $50, a put option with a strike price of $55 would be in-the money.

  At-the-Money (ATM): For both a call and a put option, it’s a strike price that’s at the same current price of the stock.

  Out-of-the-Money (OTM):

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  eBook - PDF

  Option Strategies

  Profit-Making Techniques for Stock, Stock Index, and Commodity Options

  • Courtney Smith(Author)
  • 2008(Publication Date)
  • Wiley

    (Publisher)

  You wanted to carry the instrument until a particular time, but the market took it away early. To partially protect against this, use an option that does not expire until after you want to liquidate the short put. Look at other hedge strategies, such as buying calls (see Chapter 7). This strategy implies the sale of an in-the-money put to provide protec-tion. The amount of protection will be determined largely by the delta of the option selected. The only way to protect against the whole expected price rise would be to select the quantity of the in-the-money put that has a 168 OPTION STRATEGIES delta that will cover the expected price rise. Remember, very in-the-money puts often have poor liquidity, and entering and exiting the short put may be difficult. Increase Return The second strategy is to increase return on an existing position. Where do you think the UI price is going? If you are long-term bullish, get out of the UI and invest in something else. If you are bearish, treat the covered put write as a separate trade, and follow the decision outlined in the next section. When you write a put against an existing position, you are no longer in that existing position. Many investors psychologically cling to the short position and do not realize that the sale of the put means that they have liquidated a short position and simultaneously initiated a covered put write. These are two separate trades with differing risk/reward characteristics and decision structures. Selling a put is a powerful way to increase returns on a UI for which you have a predetermined buy point. Selling a put at the strike price that corresponds to the buy point increases your returns by the amount of the premium while reducing the risk. Selling a put is essentially prebuying your short instrument. When the instrument rises to your target price, the put buyer may call away your instrument. The critical problem is identifying a valid target purchase price.

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  eBook - PDF

  Getting Started in Options

  • Michael C. Thomsett(Author)
  • 2005(Publication Date)
  • Wiley

    (Publisher)

  Pending expiration reduces the likelihood of out-of-the- money options being exercised, and distance between market price of the stock 42 OPENING, CLOSING, TRACKING: HOW IT ALL WORKS and striking price of the call means the seller’s profits are more likely to materi- alize than are the hopes of the buyer. 3. Type of option. Understanding the distinction between calls and puts is essential to success in the options market; the two are opposites. Identical strategies cannot be used for calls and puts, for reasons beyond the obvious fact that they react to stock price movement differently. Calls are by definition the right to buy 100 shares, whereas puts are the right to sell 100 shares. But merely comprehending the essential opposite nature of the two contracts is not enough. It might seem at first glance that, given the behavior of calls and puts when in the money or out of the money, it would make no difference whether you buy a put or sell a call. As long as expiration and striking price are identical, what is the difference? In practice, however, significant differ- ences do make these two ideas vastly different in terms of risk. When you buy a put, your risk is limited to the amount you pay for premium. When you sell a call, your risk can be far greater because the stock may rise many points, re- quiring the call seller to deliver 100 shares at a price far below current market value. Each specific strategy has to be reviewed in terms not only of likely price movement given a set of market price changes in the underlying stock, but also how one’s position is affected by exposure to varying degrees of risk. Some of the more exotic strategies involving the use of calls and puts at the same time, or buying and selling of the same option with different striking prices, are examples of advanced techniques, which will be explored in detail in later chapters. 4. Underlying stock. Every option is identified with a specific company’s stock, and this cannot be changed.

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  eBook - PDF

  2023 CFA Program Curriculum Level III Box Set

  • (Author)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  For a protective put, a lower exercise price is less costly and has a greater risk of loss in the position. Like traditional term insurance, this form of insurance provides coverage for a period of time. At the end of the period, the insurance expires and either pays off or not. The buyer of the insurance may or may not choose to renew the insurance by buying another put. A protective put can appear to be a great transaction with no drawbacks, because it provides downside protection with upside potential, but let us take a closer look. 4.1 Loss Protection/Upside Preservation Suppose a portfolio manager has a client with a 50,000 share position in PBR. Her research suggests there may be a negative shock to the stock price in the next four to six weeks, and he wants to guard against a price decline. Consider the put prices 4 Investment Objectives of Protective Puts 21 shown in Exhibit 6; the purchase of a protective put presents the manager with some choices. Puts represent a right to sell at the strike price, so higher-strike puts will be more expensive. For this reason, the put buyer may select the 15-strike PBR put. Longer-term American puts are more expensive than their equivalent (same strike price) shorter-maturity puts. The put buyer must be sure the put will not expire before the expected price shock has occurred. The portfolio manager could buy a one-month (SEP) 15-strike put for 0.65. This put insures against the portion of the underlying return distribution that is below 15, but it will not protect against a price shock occurring after the SEP expiration. Alternatively, the portfolio manager could buy a two-month option, paying 0.99 for an OCT 15 put, or she could buy a three-month option, paying 1.46 for a NOV 15 put. Note that there is not a linear relationship between the put value and its time until expiration.

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  Getting Started in Options

  • Michael C. Thomsett(Author)
  • 2007(Publication Date)
  • Wiley

    (Publisher)

  That is because for every point of decline in the stock’s market value, the put increases one point in intrinsic value. This status continues until the put expires. The insurance strategy is also a powerful tool when you plan to sell stock within the next three years, and you are concerned about the potential for losses by that deadline. Insurance protects your value and ensures that, even if the stock’s value declines dramatically, you will not lose by continuing to own the stock. Buying Puts: The Positive Side of Pessimism 119 FIGURE 4.4 Downside protection: buying shares and buying puts. Example A Wise Financial Planning Move: Several years ago you invested in 1,000 shares of stock and it has appreciated consistently over the years. You are planning to sell the stock in two years and use the funds as a down payment on a home. You don’t want to sell the stock until it is needed, for several reasons. You will be taxed on profits in the year sold, so you want to defer that until the latest possible moment. In addition, you would prefer to continue earning dividends and, potentially, additional profits in the stock. But you also know the stock’s value could fall. Even a temporary decline would be serious because you will need those funds at a specific date in the future. The solution: Buy 10 puts to insure the value at the striking price. Select puts with expiration dates at or beyond your target date. This reduces your stock’s value by the cost of the puts; but it also ensures that any in-the-money declines in the stock’s price will be offset by gains in the puts’ value. In this case, the decision to use puts is not merely speculative; it is necessary to insure the stock’s market value. A decline might be reversed within 6 to 120 GETTING STARTED IN OPTIONS FIGURE 4.5 A put’s profit and loss zones. 12 months, but that could create a hardship if you have a specific date in mind to buy a house.

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  The Business of Options

  Time-Tested Principles and Practices

  • Martin P. O'Connell(Author)
  • 2002(Publication Date)
  • Wiley

    (Publisher)

  This provides an opportunity for speculation without the usual constraints. 2. Getting back a loss. Some people can’t accept the fact that a trading or hedging decision didn’t work out well. Sometimes, the boss can’t accept it. The loss might have resulted from a bad decision, or from a good de- cision that wasn’t a sure thing (such as the dice example of Chapter 1). 192 USING OPTIONS IN A BUSINESS Regardless of the reason, it’s easy to imagine that the loss isn’t real yet, and that having a chance to get it back is more important than the risk of losing more. This kind of attitude can be a serious distraction from the hard-nosed analysis of profitability and risk that is necessary for a successful options business. Personal Stake in the Risk It is almost impossible to structure a job so that the hedger trades as if it were his own money. Employers and investors must be vigilant for situa- tions in which the hedger’s personal interest is not consistent with his role as a fiduciary. 193 CHAPTER 16 Positions for Corporate Hedgers T here seems to be an endless list of ways for a business to hedge financial assets or liabilities. In many hedging situations, there can be alternatives that are very different, but perfectly reasonable. No type of hedge is a good solution to all hedging problems. This chapter explores several categories of hedges. Its objective is not to itemize every possibility, nor to suggest that there is a best solution for any situation. Rather, it is an attempt to provide a feel for the advantages and disadvantages of the alternatives as well as for the thought processes that hedgers might use in making their decisions. For simplicity, there will be a single example of foreign exchange expo- sure to a known cash flow (Example 1). It will be assumed that an option EXAMPLE 1 You are a US$ based firm, expecting to receive a £10 million payment in 90 days.

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