Page 128 - DCOM510_FINANCIAL_DERIVATIVES

Unit 8: Application of Options

Notes
Figure 8.4: Payoff for writer of call option

The figure 8.4 shows the profits/losses for the sale of a three-month Nifty 2250 call option. As
the spot Nifty rises, the call option is in-the-money and the writer starts losses. If upon expiration,
Nifty closes above the strike of 2250, the buyer would exercise his option on the writer who
would suffer a loss to the extent of the difference between the Nifty-close and the strike price.
The loss that can be incurred by the writer of the option is potentially unlimited, whereas the
maximum profit is limited to the extent of the upfront option premium of ` 86.60 charged by
him.

Payoff Profile for Buyer of Put Options: Long Put

A put option gives the buyer the right to sell the underlying asset at the strike price specified in
the option. The profit/loss that the buyer makes on the option depends on the spot price of the
underlying. If upon expiration, the spot price is below the strike price, he makes a profit. Lower
the spot price more is the profit he makes. If the spot price of the underlying is higher than the
strike price, he lets his option expire unexercised. His loss in this case is the premium he paid for
buying the option. Figure 8.5 gives the payoff for the buyer of a three month put option (often
referred to as long put) with a strike of 2250 bought at a premium of 61.70.

Figure 8.5: Payoff for buyer of put option

The figure 8.5 shows the profits/losses for the buyer of a three-month Nifty 2250 put option. As
can be seen, as the spot Nifty falls, the put option is in-the-money. If upon expiration, Nifty
closes below the strike of 2250, the buyer would exercise his option and profit to the extent of the

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