Stock options definition examples
In finance, a put or put option is a stock market device which gives the owner of a put the right, but not the obligation, to sell an asset the underlyingat a specified price the strikeby a predetermined date the expiry or maturity to a given party the seller of the put. The purchase of a put option is interpreted as a negative sentiment about the future value stock options definition examples the underlying.
Put options are most commonly used in the stock market to protect against the decline of the price of a stock below a specified price. In this way the buyer of the put will receive at least the strike price specified, even if the asset is currently stock options definition examples. If the strike is Kand at time t the value of the underlying is S tthen in an American option the buyer can exercise the put for a payout of K-S t any time until the option's maturity time T.
The put yields a positive return only if the security price falls below the strike when the option is exercised. A European option can only be exercised at time T rather than any time until Tand a Bermudan option can be exercised only on specific dates listed in the terms of the contract. If the option is not exercised stock options definition examples maturity, it expires worthless. The buyer will not exercise the option at an allowable date if the price of the underlying is greater than K.
The most obvious use of a put is as a type of insurance. In the protective put strategy, the investor buys enough puts to cover his holdings of the underlying so that if a drastic downward movement of the underlying's price occurs, he has the option to sell the holdings at the strike price.
Another use is for speculation: Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging. By put-call paritya European put can be replaced by buying the appropriate call option and selling an appropriate forward contract. The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration.
The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it. The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss.
The put writer believes that the underlying security's price will stock options definition examples, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received.
Stock options definition examples can be used also to limit the writer's portfolio risk and may be part of an option spread. That is, the buyer wants the value of the put option to increase by a stock options definition examples in the price of the underlying asset below the strike price. The writer seller of a put is long on the underlying asset and short on the put option itself.
That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price. Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. A naked putalso called an uncovered putis a put option whose writer the seller does not have a position in the underlying stock or other instrument.
This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough. If the buyer fails to exercise stock options definition examples options, then the writer keeps the option premium as a "gift" for playing the game. If the underlying stock's market price is below the option's strike price when expiration arrives, the option owner buyer can exercise the put option, forcing the writer to buy the underlying stock at the strike price.
That allows the exerciser buyer to profit from the difference between the stock's market price and the option's strike price. But if the stock's market price is above the option's strike price at the stock options definition examples of expiration day, the option expires worthless, and the owner's loss is limited to the premium fee paid for it the writer's profit. The seller's potential loss on a naked put can be substantial. If the stock falls all the way to zero bankruptcyhis loss is equal to the strike price at which he must buy the stock to cover the option minus the premium received.
The potential upside is the premium received when selling the option: During the option's lifetime, if the stock moves lower, the option's premium may increase depending on how far the stock falls and how much time passes. If it does, it becomes more costly to close the position repurchase the put, sold earlierresulting in a loss.
If the stock price completely collapses before the put position is closed, the put writer potentially can face catastrophic loss. In order to protect the put buyer from default, the put writer is required to post stock options definition examples. The put buyer does not need to post margin because the buyer would not exercise the option if it had a negative payoff.
A buyer thinks the price of a stock will decrease. Stock options definition examples pays stock options definition examples premium which he will never get back, unless it is sold before it expires. The buyer has the right to sell the stock at the strike price. The writer receives a premium from the buyer. If the buyer exercises his option, the stock options definition examples will buy the stock options definition examples at the strike price.
If the buyer does not exercise his option, the writer's profit is the premium. A put option is said to stock options definition examples intrinsic value when the underlying instrument has a spot price S below the option's strike price K.
Upon exercise, a put option is valued at K-S if it is " in-the-money ", otherwise its value is zero. Prior to exercise, an option has time value apart from its intrinsic value.
The following factors reduce the time value stock options definition examples a put option: Option pricing is a central problem of financial mathematics.
Trading options involves a constant monitoring of the option value, which is affected by changes in the base asset price, volatility and time decay. Moreover, the dependence of stock options definition examples put option value to those factors is not linear stock options definition examples which stock options definition examples the analysis even more complex. The graphs clearly shows the non-linear dependence of the option value to the base asset price.
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Call and put options are examples of stock derivatives - their value is derived from the value stock options definition examples the underlying stock. For example, a call option goes up in price when the price of the underlying stock rises. And you don't have to own the stock to profit from the price rise of the stock.
A put option goes up in price when the price of the underlying stock goes down. As with a call option, you don't have to own the stock. But if you do, the put acts as a hedge - as the stock price goes down, the value of the put goes up stock options definition examples you are hedged against the downside. You make money on options if your bet on the stock options definition examples of price movement of the underlying stock is correct. If not, you'll probably loose most or all the money you paid for the option.
Options are very sensitive to changes in the stock options definition examples of the underlying stocks. Like gambling you can make or lose money very quickly. Because option prices change quite rapidly, owning them requires that you spend a significant amount of time monitoring price changes in the stock and the option. And if you're wrong about the price movement, be prepared to lose all or a significant portion of the money you paid for the options. A call is a contract that gives the owner the right, but not the obligation, to buy shares of a stock at a fixed price, called the strike price, on or before the options expiration date.
If the value of the stock goes down, the price of the option goes down, and you could hold it or sell it at a loss. The price that you pay for a call option depends on many factors two of which include: See the following videos: If you own a stock, you may buy a put as a form of insurance. If the stock falls in price, the put rises in price and helps offset the paper decline in the underlying stock.
If you don't own the stock but think it will go down in price, you buy the put to profit from the decline in price of the stock. If the stock price declines, the value of the put rises and you would sell stock options definition examples put for a profit. If the stock increases in price you may sell the put for a loss. A put option is a contract that gives you the right, but not the obligation, to sell a stock at a preset price.
The price that you pay for a put option depends the duration of stock options definition examples contract the longer the duration, the more you pay and how far the current price of the stock is from the strike price of the contract. Put buying is different from selling short. With a put option your only liability is the price you paid for the put.
With a short sale, you have an unlimited downside liability if the stock goes up. Also, the proceeds from selling short are in a margin account so you have to pay interest and meet margin requirements. Buying puts is a more conservative way of betting on a stock declining in price.
Selling a Stock options definition examples For every buyer of a call there must be a seller, who assumes that the stock price will remain flat or go down.
The seller collects the purchase price of the option but has the obligation to sell shares stock options definition examples the stock if the buyer decides to exercise the option. If the seller gets called - he must sell the stock. If the stock continues to appreciate in price after the stock is sold, the seller looses the future price gain. In most cases you stock options definition examples own shares of the stock for each contract you sell - this is called a covered call.
Therefore, if your stock gets called away, you have the shares in your account. You stock options definition examples sell covered calls to generate a stream of income. If the stock price does not rise enough during the period of the contract, you won't get called and won't have to sell the stock so you keep the money you received when you sold the call.
If your broker lets you, you may sell stock options definition examples "or "naked" calls in a margin account. This practice lets you sell calls when you don't own the stock. If you get called, you must buy the stock at its current market value to cover the call even when the market price is higher than the strike price of the option.
Like any margin account transaction, you must execute the transaction immediately. The seller of a put collects the purchase price of the option from the buyer of the put. The seller has the obligation to buy shares at the strike price regardless of the market value of the underlying stock.
So if the put buyer decides to exercise the put contract, the seller of the put has to buy the shares at the strike price no matter the current market value of the stock.
When you sell a put, you want the price of the stock to go up so you don't get the stock put to you - buy the stock for more than it's worth. Selling a put places the money you receive in a margin account so you pay interest on the proceeds until the put contract is closed. If you don't have the financial resources to cover the obligation of buying the stock from the buyer of the put, you sold stock options definition examples puts".
It tells about a stock options definition examples who sold naked puts and experienced financial ruin. It was an unhedged bet, or what was called on Wall Street a "naked put" On October 27,the market plummeted seven per cent, and Niederhoffer had to produce huge amounts of cash to back up all the options he'd sold at pre-crash strike prices. He ran through a hundred and thirty million dollars - his cash reserves, his savings, his other stocks-and when his broker came and asked for still more he didn't have it.
In a day, one of the most successful hedge funds in America was wiped out. Niederhoffer was forced to shut down his firm. He had to mortgage his house. He had to borrow money from his children. He had to call Sotheby's and sell his prized silver collection Use calls and puts judiciously. If you're right, you can make quick money. If you're wrong, you can lose part or all of your investment very quickly.
Do not sell "naked" options. You may be inviting a financial disaster. Knowledgeable, experienced investors may want to sell covered calls and puts to collect other peoples money. Because the price of options can change very quickly and dramatically, you must continually watch their price movement.
If you not prepared to stock options definition examples so, don't buy or sell options. Alternative Actions for the Call Buyer.
Stock options definition examples Actions for the Put Buyer. Alternative Actions for the Stock options definition examples Seller. Alternative Actions for the Put Seller. What the call buyer may do. Exercise call option if the stock price rises above the strike price. Buy shares at stock options definition examples price, which is less than market price buy stock for less than it's worth.
Exercise option if the stock price declines. Sell shares at strike price, which is more than market price sell stock for more than it's worth. Put buyer must own shares to sell. Can already own them or buy them at market price, which is less than strike price. What the call seller stock options definition examples do. Sell shares at the strike price to the call buyer if the call buyer exercises the call option. If the call seller already has shares in his account, they are sold to the buyer at the strike price.
If the call seller does not have shares, he must buy the shares on the open market at a price greater than the strike price.
What the put stock options definition examples must do. Buy shares from the put buyer if the put buyer exercises the put option. If the put seller already has money in his account to buy the stock, the put option is covered. If the seller does not have money to buy the stock, the put option is naked. The put seller must come up with money to buy the stock.