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Put Option

Definition:
A put option is an option contract in which the holder (buyer) has the right (but not the
obligation) to sell a specified quantity of a security at a specified price (strike price) within a
fixed period of time (until its expiration).

For the writer (seller) of a put option, it represents an obligation to buy the underlying security at
the strike price if the option is exercised. The put option writer is paid a premium for taking on
the risk associated with the obligation.

For stock options, each contract covers 100 shares.

Buying Put Options


Put buying is the simplest way to trade put options. When the options trader is bearish on
particular security, he can purchase put options to profit from a slide in asset price. The price of
the asset must move significantly below the strike price of the put options before the option
expiration date for this strategy to be profitable.

A Simplified Example

Suppose the stock of XYZ company is trading at $40. A put option contract with a strike price of
$40 expiring in a month's time is being priced at $2. You strongly believe that XYZ stock will
drop sharply in the coming weeks after their earnings report. So you paid $200 to purchase a
single $40 XYZ put option covering 100 shares.
Say you were spot on and the price of XYZ stock plunges to $30 after the company reported
weak earnings and lowered its earnings guidance for the next quarter. With this crash in the
underlying stock price, your put buying strategy will result in a profit of $800.

Let's take a look at how we obtain this figure.

If you were to exercise your put option after earnings, you invoke your right to sell 100 shares of
XYZ stock at $40 each. Although you don't own any share of XYZ company at this time, you
can easily go to the open market to buy 100 shares at only $30 a share and sell them immediately
for $40 per share. This gives you a profit of $10 per share. Since each put option contract covers
100 shares, the total amount you will receive from the exercise is $1000. As you had paid $200
to purchase this put option, your net profit for the entire trade is $800.

This strategy of trading put option is known as the long put strategy. See our long put strategy
article for a more detailed explanation as well as formulae for calculating maximum profit,
maximum loss and breakeven points.

Protective Puts

Investors also buy put options when they wish to protect an existing long stock position. Put
options employed in this manner are also known as protective puts. Entire portfolio of stocks can
also be protected using index puts.

Selling Put Options


Instead of purchasing put options, one can also sell (write) them for a profit. Put option writers,
also known as sellers, sell put options with the hope that they expire worthless so that they can
pocket the premiums. Selling puts, or put writing, involves more risk but can be profitable if
done properly.

Covered Puts

The written put option is covered if the put option writer is also short the obligated quantity of
the underlying security. The covered put writing strategy is employed when the investor is
bearish on the underlying.

Naked Puts

The short put is naked if the put option writer did not short the obligated quantity of the
underlying security when the put option is sold. The naked put writing strategy is used when the
investor is bullish on the underlying.

For the patient investor who is bullish on a particular company for the long haul, writing naked
puts can also be a great strategy to acquire stocks at a discount.
Put Spreads
A put spread is an options strategy in which equal number of put option contracts are bought and
sold simultaneously on the same underlying security but with different strike prices and/or
expiration dates. Put spreads limit the option trader's maximum loss at the expense of capping his
potential profit at the same time.

Call Option
Definition:
A call option is an option contract in which the holder (buyer) has the right (but not the
obligation) to buy a specified quantity of a security at a specified price (strike price) within a
fixed period of time (until its expiration).

For the writer (seller) of a call option, it represents an obligation to sell the underlying security at
the strike price if the option is exercised. The call option writer is paid a premium for taking on
the risk associated with the obligation.

For stock options, each contract covers 100 shares.

Buying Call Options


Call buying is the simplest way of trading call options. Novice traders often start off trading
options by buying calls, not only because of its simplicity but also due to the large ROI generated
from successful trades.

A Simplified Example

Suppose the stock of XYZ company is trading at $40. A call option contract with a strike price of
$40 expiring in a month's time is being priced at $2. You strongly believe that XYZ stock will
rise sharply in the coming weeks after their earnings report. So you paid $200 to purchase a
single $40 XYZ call option covering 100 shares.
Say you were spot on and the price of XYZ stock rallies to $50 after the company reported
strong earnings and raised its earnings guidance for the next quarter. With this sharp rise in the
underlying stock price, your call buying strategy will net you a profit of $800.

Let us take a look at how we obtain this figure.

If you were to exercise your call option after the earnings report, you invoke your right to buy
100 shares of XYZ stock at $40 each and can sell them immediately in the open market for $50 a
share. This gives you a profit of $10 per share. As each call option contract covers 100 shares,
the total amount you will receive from the exercise is $1000.

Since you had paid $200 to purchase the call option, your net profit for the entire trade is $800. It
is also interesting to note that in this scenario, the call buying strategy's ROI of 400% is very
much higher than the 25% ROI achieved if you were to purchase the stock itself.

This strategy of trading call options is known as the long call strategy. See our long call strategy
article for a more detailed explanation as well as formulae for calculating maximum profit,
maximum loss and breakeven points.

Selling Call Options


Instead of purchasing call options, one can also sell (write) them for a profit. Call option writers,
also known as sellers, sell call options with the hope that they expire worthless so that they can
pocket the premiums. Selling calls, or short call, involves more risk but can also be very
profitable when done properly. One can sell covered calls or naked (uncovered) calls.

Covered Calls
The short call is covered if the call option writer owns the obligated quantity of the underlying
security. The covered call is a popular option strategy that enables the stockowner to generate
additional income from their stock holdings thru periodic selling of call options. See our covered
call strategy article for more details.

Naked (Uncovered) Calls

When the option trader write calls without owning the obligated holding of the underlying
security, he is shorting the calls naked. Naked short selling of calls is a highly risky option
strategy and is not recommended for the novice trader. See our naked call article to learn more
about this strategy.

Call Spreads
A call spread is an options strategy in which equal number of call option contracts are bought
and sold simultaneously on the same underlying security but with different strike prices and/or
expiration dates. Call spreads limit the option trader's maximum loss at the expense of capping
his potential profit at the same time.

Strike Price
Definition:
The strike price is defined as the price at which the holder of an options can buy (in the case of a
call option) or sell (in the case of a put option) the underlying security when the option is
exercised. Hence, strike price is also known as exercise price.

Strike Price, Option Premium & Moneyness


When selecting options to buy or sell, for options expiring on the same month, the option's price
(aka premium) and moneyness depends on the option's strike price.

Relationship between Strike Price & Call Option Price

For call options, the higher the strike price, the cheaper the option. The following table lists
option premiums typical for near term call options at various strike prices when the underlying
stock is trading at $50

Strike Price Moneyness Call Option Premium Intrinsic Value Time Value
35 ITM $15.50 $15 $0.50
40 ITM $11.25 $10 $1.25
45 ITM $7 $5 $2
50 ATM $4.50 $0 $4.50
55 OTM $2.50 $0 $2.50
60 OTM $1.50 $0 $1.50
65 OTM $0.75 $0 $0.75

Relationship between Strike Price & Put Option Price

Conversely, for put options, the higher the strike price, the more expensive the option. The
following table lists option premiums typical for near term put options at various strike prices
when the underlying stock is trading at $50

Strike Price Moneyness Put Option Premium Intrinsic Value Time Value
35 OTM $0.75 $0 $0.75
40 OTM $1.50 $0 $1.50
45 OTM $2.50 $0 $2.50
50 ATM $4.50 $0 $4.50
55 ITM $7 $5 $2
60 ITM $11.25 $10 $1.25
65 ITM $15.50 $15 $0.50

Strike Price Intervals


The strike price intervals vary depending on the market price and asset type of the underlying.
For lower priced stocks (usually $25 or less), intervals are at 2.5 points. Higher priced stocks
have strike price intervals of 5 point (or 10 points for very expensive stocks priced at $200 or
more). Index options typically have strike price intervals of 5 or 10 points while futures options
generally have strike intervals of around one or two points.

Options Premium
The price paid to acquire the option. Also known simply as option price. Not to be confused with
the strike price. Market price, volatility and time remaining are the primary forces determining
the premium. There are two components to the options premium and they are intrinsic value and
time value.

Intrinsic Value
The intrinsic value is determined by the difference between the current trading price and the
strike price. Only in-the-money options have intrinsic value. Intrinsic value can be computed for
in-the-money options by taking the difference between the strike price and the current trading
price. Out-of-the-money options have no intrinsic value.
Time Value
An option's time value is dependent upon the length of time remaining to exercise the option, the
moneyness of the option, as well as the volatility of the underlying security's market price.

The time value of an option decreases as its expiration date approaches and becomes worthless
after that date. This phenomenon is known as time decay. As such, options are also wasting
assets.

For in-the-money options, time value can be calculated by subtracting the intrinsic value from
the option price. Time value decreases as the option goes deeper into the money. For out-of-the-
money options, since there is zero intrinsic value, time value = option price.

Typically, higher volatility give rise to higher time value. In general, time value increases as the
uncertainty of the option's value at expiry increases.

Effect of Dividends on Time Value

Time value of call options on high cash dividend stocks can get discounted while similarly, time
value of put options can get inflated. For more details on the effect of dividends on option
pricing, read this article.

Moneyness
Moneyness is a term describing the relationship between the strike price of an option and the
current trading price of its underlying security. In options trading, terms such as in-the-money,
out-of-the-money and at-the-money describe the moneyness of options.

In-the-Money (ITM)

A call option is in-the-money when its strike price is below the current trading price of the
underlying asset.

A put option is in-the-money when its strike price is above the current trading price of the
underlying asset.

In-the-money options are generally more expensive as their premiums consist of significant
intrinsic value on top of their time value.

Out-of-the-Money (OTM)

Calls are out-of-the-money when their strike price is above the market price of the underlying
asset.
Puts are out-of-the-money when their strike price is below the market price of the underlying
asset.

Out-of-the-money options have zero intrinsic value. Their entire premium is composed of only
time value. Out-of-the-money options are cheaper than in-the-money options as they possess
greater likelihood of expiring worthless.

At-the-Money (ATM)

An at-the-money option is a call or put option that has a strike price that is equal to the market
price of the underlying asset. Like OTM options, ATM options possess no intrinsic value and
contain only time value which is greatly influenced by the volatility of the underlying security
and the passage of time.

Often, it is not easy to find an option with a strike price that is exactly equal to the market price
of the underlying. Hence, close-to-the-money or near-the-money options are bought or sold
instead.

Options Expiration
All options have a limited useful lifespan and every option contract is defined by an expiration
month. The option expiration date is the date on which an options contract becomes invalid and
the right to exercise it no longer exists.

When do Options Expire?

For all stock options listed in the United States, the expiration date falls on the third Friday of
the expiration month (except when that Friday is also a holiday, in which case it will be
brought forward by one day to Thursday).

Expiration Cycles

Stock options can belong to one of three expiration cycles. In the first cycle, the JAJO cycle, the
expiration months are the first month of each quarter - January, April, July, October. The second
cycle, the FMAN cycle, consists of expiration months Febuary, May, August and November.
The expiration months for the third cycle, the MJSD cycle, are March, June, September and
December.

At any given time, a minimum of four different expiration months are available for every
optionable stock. When stock options first started trading in 1973, the only expiration months
available are the months in the expiration cycle assigned to the particular stock.

Later on, as options trading became more popular, this system was modified to cater to investors'
demand to use options for shorter term hedging. The modified system ensures that two near-
month expiration months will always be available for trading. The next two expiration months
further out will still depend on the expiration cycle that was assigned to the stock.

Determining the Expiration Cycle

As there is no set pattern as to which expiration cycle a particular optionable stock is assigned to,
the only way to find out is to deduce from the expiration months that are currently available for
trading. To do that, just look at the third available expiration month and see which cycle it
belongs to. If the third expiration month happens to be January, then use the fourth expiration
month to check.

The reason we need to double check January is because LEAPS expire in January and if the
stock has LEAPS listed for trading, then that January expiration month is the additional
expiration month added for the LEAPS options.

Option Exercise & Assignment

Exercise
To exercise an option is to execute the right of the holder of an option to buy (for call options) or
sell (for put options) the underlying security at the striking price.

American Style vs European Style

American style options can be exercised anytime before the expiration date. European style
options on the other hand can only be exercised on the expiration date itself. Currently, all of the
stock options traded in the marketplaces are American-Style options.

When an option is exercised by the option holder, the option writer will be assigned the
obligation to deliver the terms of the options contract.

Assignment
Assignment takes place when the written option is exercised by the options holder. The options
writer is said to be assigned the obligation to deliver the terms of the options contract.

If a call option is assigned, the options writer will have to sell the obligated quantity of the
underlying security at the strike price.

If a put option is assigned, the options writer will have to buy the obligated quantity of the
underlying securty at the strike price.
Once an option is sold, there exist a possibility for the option writer to be assigned to fulfil his or
her obligation to buy or sell shares of the underlying stock on any business day. One can never
tell when an assignment will take place. To ensure a fair distribution of assignments, the Options
Clearing Corporation uses a random procedure to assign exercise notices to the accounts
maintained with OCC by each Clearing Member. In turn, the assigned firm must use an
exchange approved way to allocate those notices to individual accounts which have the short
positions on those options.

Options are usually exercised when they get closer to expiration. The reason is that it does not
make much sense to exercise an option when there is still time value left. Its more profitable to
sell the option instead.

Over the years, only about 17% of options have been exercised. However, it does not mean that
only 17% of your short options will be exercised. Many of those options that were not exercised
were probably out-of-the-money to begin with and had expired worthless. In any case, at any
point in time, the deeper into-the-money the short options, the more likely they will be exercised

In-The-Money Puts
Options with intrinsic value are known as in-the-money (ITM) options.

A put option is in-the-money when the strike price is above the current trading price of the
underlying security.

Looking for strategies to trade Nifty options.


(Day trades and positional trades)
Particularly looking for insights from personal trading experiences. These could be in the form of
lessons learned, observations made, etc.

Pramod Kumar, Making Money in Options Trading Regularly


Written Jan 18
As I write, NIFTY is at about 8455. I am looking for a safe trade for reasonable returns. My view
about the market is that having moved up considerably from last expiry, NIFTY will face
resistance now and by February expiry close below 8400 after some volatility. I may be wrong,
so I am looking for a safe trade in which I suffer no loss while going wrong.

NIFTY Movement in Last One Year:

Except for February , September and November 2016, market has not been very volatile in last
year. Apparently selling options should have been profitable. On the contrary, if someone had
sold at the nearest strike every month and held that position, there would have been some loss.

Read about it here:

Pramod Kumar's answer to What are the risks involved in selling put options as a means of
earning a regular income?

Had you bought a PUT of the nearest expiry for the next expiry, you would have made 9 losses
and 3 profits in the year; but the 3 profitable transactions would have been more than 9 losing
ones.

But we do not have patience to wait for the market to reward us for our trades.And it is difficult
also to just keep on waiting.

My Preferred NIFTY Trade :

As of now, NIFTY is at 8456.

I would Buy NIFTY 8500 PUT Feb 23 for Rs. 151 and

Sell NIFTY 8400 PUT Feb 23 for Rs. 115 and

Sell NIFTY 8100 PUT Feb 23 for Rs. 44.

The trade set up gives an initial cash flow of Rs. 8 ( Rs. 600 for 1 lot of NIFTY )

If NIFTY stays between 8400 to 8100, the profit will be 100 points i.e. Rs. 7500.

There is absolutely no loss in case of going wrong.

The small profit of Rs. 600 stays with me even if NIFTY goes to 9000.

Where Is The Risk ? :

If NIFTY crashes suddenly to levels below 8100. It is safe up to 8000. After that it starts losing
money.
In such a situation, I take whatever loss is to be booked and exit when Nifty goes below 8000.

I have seen that such trades give mostly no loss ( when you are absolutely wrong ) , small profit
of about 6–7 percent ( when you are right ) and small loss ( when you are right but it goes out of
range ).

On an annual basis, there shall be small profit, I mean in the range of 24–36% on annualized
basis on the amount invested. ( Cost of buying the option plus the margin money for selling the
option )

There must certainly be a fancy name for this strategy unknown to me. I would request the
readers to tell me the same if they happen to know.

Please Note:

This is what I would do. In no case it should be taken as an advice or invitation to initiate this
trade. I mentioned this as an example of a relatively safe trade.

Here at least there will be no loss in case you are absolutely wrong.

This strategy works for me and should work for bullish expectations too.