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RATIONALE OF BUYING A PUT OPTION

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RATIONALE OF BUYING A PUT OPTION
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Sunanda K. Chavan
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RATIONALE OF BUYING A PUT OPTION - October 8th, 2010

An investor, if he anticipates fall in the price of some stock, has the following alternatives:

1. Sell the stock short, i.e. enter a sales transaction without owning the stock. In the event of a fall in the stock price, he can buy the stock at a lower price and can deliver the stock sold to the buyer, thus making profit equal to the fall in the price. However, in case the stock price appreciates instead of declining, the investor would be exposed to unlimited loss.

2. Write a call option without owning the stock, i.e. writing a naked call option. Writing such an option is similar to selling short, the only difference being that the loss in the event of appreciation in the stock price would be curtailed to the extent of the premium re¬ceived on writing the call option, which may not be sufficient at¬traction.

3. Purchase a put option. The purchase of a put option is the most de¬sirable policy as compared to either going short or writing a naked call option.

The first reason is that the investment in buying a put option is restricted to the premium as against a larger sum required for going short. Thus, as in the case of a call option, the return on investment on buying a put option is much higher as compared to going short on the stock.

Secondly, in the event of increase in the stock price, the loss to the put option buyer is restricted to the premium paid.


Option Type Buyer of Call Writer of Call
(Long Position) (Short Position)
Call Right to buy asset Obligation to sell asset
Put Right to sell asset Obligation to buy asset
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Re: RATIONALE OF BUYING A PUT OPTION
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Rose Marry
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Re: RATIONALE OF BUYING A PUT OPTION - April 19th, 2016

Quote:
Originally Posted by sunandaC View Post
An investor, if he anticipates fall in the price of some stock, has the following alternatives:

1. Sell the stock short, i.e. enter a sales transaction without owning the stock. In the event of a fall in the stock price, he can buy the stock at a lower price and can deliver the stock sold to the buyer, thus making profit equal to the fall in the price. However, in case the stock price appreciates instead of declining, the investor would be exposed to unlimited loss.

2. Write a call option without owning the stock, i.e. writing a naked call option. Writing such an option is similar to selling short, the only difference being that the loss in the event of appreciation in the stock price would be curtailed to the extent of the premium re¬ceived on writing the call option, which may not be sufficient at¬traction.

3. Purchase a put option. The purchase of a put option is the most de¬sirable policy as compared to either going short or writing a naked call option.

The first reason is that the investment in buying a put option is restricted to the premium as against a larger sum required for going short. Thus, as in the case of a call option, the return on investment on buying a put option is much higher as compared to going short on the stock.

Secondly, in the event of increase in the stock price, the loss to the put option buyer is restricted to the premium paid.


Option Type Buyer of Call Writer of Call
(Long Position) (Short Position)
Call Right to buy asset Obligation to sell asset
Put Right to sell asset Obligation to buy asset
Hey friend,

Please check attachment for Theory of rational option pricing, so please download and check it.
Attached Files
File Type: pdf Theory of rational option pricing.pdf (2.75 MB, 0 views)
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