In a put option, since the investor with a long position has a right to sell the stock and the writer is obliged to buy it at the will of the buyer, the profit profile is different from the one in a call option where the rights and obligations are different.
Consider a put option contract on a certain share, PQP, Suppose, two investors X and Y enter into a contract and take short and long positions respectively.
The other details are given below:
Exercise price = Rs I 10
Expiration month = March, 2001
Size of contract= I 00 shares
Date of entering into contract =January 6, 2001
Share price on the date of contract = Rs 1 12
Price of put option on the date of contract = Rs 7.50
Now, as the contract is entered into, the writer of the option, X will receive Rs 750 (=7.50 x 100) from the buyer, Y At the time of maturity, the gain/loss to each party depends on the ruling price of the share. If the price of the share is Rs 110 or greater than that, the option will not be exercised, so that the writer pockets the amount of put premium-the maximum profit which can accrue to a seller.
At the same time, it represents the maximum loss that the buyer is exposed to. If the price of the share falls below the exercise price, a loss would result to the writer and a gain to the buyer. The maximum loss that the writer may theoretically be exposed to is limited by the amount of the exercise price. Thus, if the value of the underlying share falls to zero, the loss to the writer is equal to Rs. 110 – Rs. 7.50 = Rs. 102.50 per share
Consider a put option contract on a certain share, PQP, Suppose, two investors X and Y enter into a contract and take short and long positions respectively.
The other details are given below:
Exercise price = Rs I 10
Expiration month = March, 2001
Size of contract= I 00 shares
Date of entering into contract =January 6, 2001
Share price on the date of contract = Rs 1 12
Price of put option on the date of contract = Rs 7.50
Now, as the contract is entered into, the writer of the option, X will receive Rs 750 (=7.50 x 100) from the buyer, Y At the time of maturity, the gain/loss to each party depends on the ruling price of the share. If the price of the share is Rs 110 or greater than that, the option will not be exercised, so that the writer pockets the amount of put premium-the maximum profit which can accrue to a seller.
At the same time, it represents the maximum loss that the buyer is exposed to. If the price of the share falls below the exercise price, a loss would result to the writer and a gain to the buyer. The maximum loss that the writer may theoretically be exposed to is limited by the amount of the exercise price. Thus, if the value of the underlying share falls to zero, the loss to the writer is equal to Rs. 110 – Rs. 7.50 = Rs. 102.50 per share