Page 104 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Unit 7: Option Strategies and Pay-offs

Notes
Figure 7.26: Pay-off Profile of Seller of Call Option

Profit +
Profit=
Unlimited
Increasing Underlying
Stock Price
o

Loss=
Limited
Loss –
Short call
7.4.3 Buyer of Put Option

A put option gives the holder the right to sell an asset at a certain price within a specific period
of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the
price of the stock will fall before the option expires.
The buyer of an equity put option has purchased the right, but not the obligation, to sell 100
shares of the underlying stock at the stated exercise price at any time before the option expires.
Once the option is purchased the buyer is then "long" the put contract, and to sell 100 underlying
shares he notifies his brokerage firm of his intent to exercise the put contract.

Example: The buyer of one XYZ June 70 put option has the right to sell 100 shares of XYZ
stock at ` 70 per share up until the June expiration.
Figure 7.27: Pay-off Profile of Buyer of Put Option

Profit + Profit=

Substantial
Increasing Underlying
Stock Price
o

Loss=
Limited
Loss –
Long Put

Potential Profit: Substantial and increases as the underlying stock price decreases to zero.
Potential Loss: Limited to premium paid for put.

LOVELY PROFESSIONAL UNIVERSITY 99