- Criteria for Successful Investing
- Risk Profile Charts
- The Definition of an Option
- The Valuation of Options
- Intrinsic and Time Value for Calls
- Intrinsic and Time Value for Puts
- The Seven Factors that Influence an Option’s Premium
- Risk Profile Charts for Call Options
- Risk Profile Charts for Put Options
- Memory Tips for Long and Short Calls and Puts
- Basic Risk Profiles Summary
- Chapter 1 Major Learning Points
This chapter is from the book
This chapter is from the book
This chapter is from the book
Risk Profile Charts for Put Options
Now that you know what long and short calls look like, let’s look at the risk profile of a put option.
We already know that a put option is the right to sell an asset. Logically, this suggests that the put option risk profile direction will be the opposite to that of calls or buying the asset itself. So let’s have a look at an example:
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Chart 1.5 Long put option risk profile.
Look back to Example 1.4 where you buy a put option as follows:
|
Stock price |
$77.00 |
|
Put premium |
$5.58 |
|
Exercise price |
$80 |
|
Time till expiration |
4 months |
Remember that. . .
Buying Gives You the Right
- Buying a put option gives you the right, not the obligation, to sell an underlying instrument (that is, a share).
- When you buy a put option, you are not obligated to sell the underlying instrument—you simply have the right to do so at the fixed (exercise or strike) price.
- Your risk, when you buy an option, is simply the price you paid for it.
- Your reward is potentially unlimited. With long puts your reward is unlimited to the downside, for example, the exercise price less the price you paid for the put itself. In this example that is: $80 - $5.58 = $74.42.
For every put you buy, there is someone else on the other side of the trade. The seller of a put option will have a different risk profile to that of the put option buyer.
)
Chart 1.6 Short put option risk profile.
Still taking Example 1.4 of the following put option:
|
Stock price |
$77.00 |
|
Put premium |
$5.58 |
|
Exercise price |
$80 |
|
Time till expiration |
4 months |
Remember that we already discussed the implications of selling an option—here’s another reminder for puts:
Selling (Naked) Imposes the Obligation
- Selling a put option obliges you to buy the underlying asset to the option buyer. Remember, when you sell a put, you have sold the right to sell to the person who bought that put.
- Selling options naked (for example, when you have not bought a position in the underlying instrument or an option to hedge against it) will give you an unlimited risk profile. The continuous downward line is generally not a good sign because it means unlimited potential risk.
- Combined with the fact that you are obliged to do something, this is generally not a preferable position in which to put yourself.
If any of that was slightly confusing to you, here are some simple ways to remember: