06 May 2009
what is the concept of Call and Put option in stock market.i dont want the defination . please explain me with the help of a practical example
Buying an XYZ July 50 call option gives you the right to purchase 100 shares of XYZ common stock at a cost of Rs. 50 per share at any time before the option expires in July. The right to buy stock at a fixed price becomes more valuable as the price of the underlying stock increases.
Assume that the price of the underlying shares was Rs. 50 at the time you bought your option and the premium you paid was Rs. 3.50 (or Rs. 350). If the price of XYZ stock climbs to Rs. 55 before your option expires and the premium rises to Rs. 5.50 you have two choices in disposing of your in-the-money option:
You can exercise your option and buy the underlying XYZ stock for Rs. 50 a share for a total cost of Rs. 5,350 (including the Option premium) and simultaneously sell the shares on the stock market for Rs. 5,500 yielding a net profit of Rs. 150. You can close out your position by selling the option contract for Rs. 550, collecting the difference between the premium received and paid, Rs. 200. In this case, you make a profit of 57% (Rs. 200/Rs. 350), whereas your profit on an outright stock purchase, given the same price movement, would be only 10% (Rs. 55-Rs. 50/Rs. 50).The profitability of similar examples will depend on how the time remaining until expiration affects the premium. Remember, time value declines sharply as an option nears its expiration date. Also influencing your decision will be whether or not you wish to own the stock.
If the price of XYZ instead fell to Rs. 45 and the option premium fell to Rs. 1.00, you could sell your option to partially offset the premium you paid. Otherwise, the option would expire worthless and your loss would be the total amount of the premium paid -(Rs. 350). In most cases, the loss on the option would be less than what you would have lost had you bought the underlying shares outright, Rs. 262.50 versus Rs. 500 in this example.
Buying Puts
If you’re Bearish
Buying an XYZ July 50 put gives you the right to sell 100 shares of XYZ stock at Rs. 50 per share at any time before the option expire in July. This right to sell stock at a fixed price becomes more valuable as the stock price declines. Assume that the price of the underlying shares was Rs. 50 at the time you bought your option and the premium you paid was Rs. 4 (or Rs. 400). If the price of XYZ falls to Rs. 45 before July and the premium rises to Rs. 6, you have two choices in disposing of your put option which is now in-the-money:
You can buy 100 shares of XYZ stock at Rs. 45 per share and simultaneously exercise your put option to sell XYZ at Rs. 50 per share, netting a profit of Rs. 100 (Rs. 500 profit on the stock less the Rs. 400 Option premium).
You can sell your put option contract, collecting the difference between the premium paid and the premium received, which is Rs. 200 in this case. If, however, the holder has chosen not to act, their maximum loss using this strategy would be the total cost of the put option (Rs. 400). The profitability of similar examples depends on how the time remaining until expiration affects the premium. Remember, time value declines sharply as an option nears its expiration date.
If XYZ prices instead had climbed to Rs. 55 prior to expiration and the premium fell to Rs. 1.50, your put option would be out-of-the-money. You could still sell your option for Rs. 150, partially offsetting its original price. In most cases, the cost of this strategy will be less than what you would have lost had you shorted XYZ stock instead of purchasing the put option, Rs. 250 versus Rs. 500 in this case.
Buying an XYZ July 50 call option gives you the right to purchase 100 shares of XYZ common stock at a cost of Rs. 50 per share at any time before the option expires in July. The right to buy stock at a fixed price becomes more valuable as the price of the underlying stock increases.
Assume that the price of the underlying shares was Rs. 50 at the time you bought your option and the premium you paid was Rs. 3.50 (or Rs. 350). If the price of XYZ stock climbs to Rs. 55 before your option expires and the premium rises to Rs. 5.50 you have two choices in disposing of your in-the-money option:
You can exercise your option and buy the underlying XYZ stock for Rs. 50 a share for a total cost of Rs. 5,350 (including the Option premium) and simultaneously sell the shares on the stock market for Rs. 5,500 yielding a net profit of Rs. 150. You can close out your position by selling the option contract for Rs. 550, collecting the difference between the premium received and paid, Rs. 200. In this case, you make a profit of 57% (Rs. 200/Rs. 350), whereas your profit on an outright stock purchase, given the same price movement, would be only 10% (Rs. 55-Rs. 50/Rs. 50).The profitability of similar examples will depend on how the time remaining until expiration affects the premium. Remember, time value declines sharply as an option nears its expiration date. Also influencing your decision will be whether or not you wish to own the stock.
If the price of XYZ instead fell to Rs. 45 and the option premium fell to Rs. 1.00, you could sell your option to partially offset the premium you paid. Otherwise, the option would expire worthless and your loss would be the total amount of the premium paid -(Rs. 350). In most cases, the loss on the option would be less than what you would have lost had you bought the underlying shares outright, Rs. 262.50 versus Rs. 500 in this example.
Puts option
If you’re Bearish
Buying an XYZ July 50 put gives you the right to sell 100 shares of XYZ stock at Rs. 50 per share at any time before the option expire in July. This right to sell stock at a fixed price becomes more valuable as the stock price declines. Assume that the price of the underlying shares was Rs. 50 at the time you bought your option and the premium you paid was Rs. 4 (or Rs. 400). If the price of XYZ falls to Rs. 45 before July and the premium rises to Rs. 6, you have two choices in disposing of your put option which is now in-the-money:
You can buy 100 shares of XYZ stock at Rs. 45 per share and simultaneously exercise your put option to sell XYZ at Rs. 50 per share, netting a profit of Rs. 100 (Rs. 500 profit on the stock less the Rs. 400 Option premium).
You can sell your put option contract, collecting the difference between the premium paid and the premium received, which is Rs. 200 in this case. If, however, the holder has chosen not to act, their maximum loss using this strategy would be the total cost of the put option (Rs. 400). The profitability of similar examples depends on how the time remaining until expiration affects the premium. Remember, time value declines sharply as an option nears its expiration date.
If XYZ prices instead had climbed to Rs. 55 prior to expiration and the premium fell to Rs. 1.50, your put option would be out-of-the-money. You could still sell your option for Rs. 150, partially offsetting its original price. In most cases, the cost of this strategy will be less than what you would have lost had you shorted XYZ stock instead of purchasing the put option, Rs. 250 versus Rs. 500 in this case.
06 May 2009
Options come in two varieties, calls and puts, and you can buy or sell either type. You make those choices - whether to buy or sell and whether to choose a call or a put - based on what you want to achieve as an options investor.
Now the Option has three elements strike price Expiration date and the variety
Strike price is the price at which contract is negotiated
Now i will take an example Person A and person B enter into the options contract A agrees to buy shares of XYZ co at a price of Rs.240/- per share after one month let the date be 4th of June now here in the example
Strike price is Rs.240/- Expiration Date is 4th june and the parties are called Mr.A is a Holder of the option and Mr.B is the Writer of the option
Now how to know whether it is a call or put option This is a call option as this is a contract for buying and of the contract is for selling it is a Put option
In the same example if A agrees to sell the shares at Rs.240/- at the agreed date then it becomes a put option
Now comes the question of premium For the writer of the option an amount is paid as premium for taking this risk it is the income of the writer
now lets see the same example suppose the premium is Rs.10 Now if the Share market goes up and the price of the above share become Rs.265 Now A has an option to buy an Rs 240 so he gains Rs.25/- that is 265 - 240 and his cost will be\ the premium of Rs.10 so his net gain is Rs.15 Thsi position is called "in the money"
Now comes the question of premium For the writer of the option an amount is paid as premium for taking this risk it is the income of the writer now lets see the same example suppose the premium is Rs.10 Now if the Share market goes up and the price of the above share become Rs.265 Now A has an option to buy an Rs 240 so he gains Rs.25/- that is 265 - 240 and his cost will be\ the premium of Rs.10 so his net gain is Rs.15 Thsi position is called "in the money"
Now imagine if the share price remains the same say 240 now he will hav to buy at 240 and still hav cost of Rs.10 for premium thsi situation means |Out of the Money" And nobody will excercise the option when they are out of the money now this is the whole concept now read this
What a particular options contract is worth to a buyer or seller is measured by how likely it is to meet their expectations. In the language of options, that's determined by whether or not the option is, or is likely to be, in-the-money or out-of-the-money at expiration. A call option is in-the-money if the current market value of the underlying stock is above the exercise price of the option, and out-of-the-money if the stock is below the exercise price. A put option is in-the-money if the current market value of the underlying stock is below the exercise price and out-of-the-money if it is above it. If an option is not in-the-money at expiration, the option is assumed to be worthless.
now let me make it clear again when a person gets the option what is his aim his aim is to protect the future risk if i want to buy L&T share at Rs.240 say and I expect that the price will go up to 260 next month I can cover this by taking an option but for this i pay the premium to the writer say this is Rs.10 now suppose as per my expectation market goes to 260/- he is the one who gives you options then my net gain is Rs.20 minus Rs.10 so we are in the money
if there is a situation where the price is Rs.250 or less on the expiration date then there is no use in excersing the options Hence i will not buy the shares in that case i am out of the money and i take advantage of the contract
CAclubindia
