Education Series

Education Series on Derivative Contracts

Naked Calls:

A naked call is one where the seller of the call option does not have position in the underlying asset.

Put Option
Put Option refers to a type of option contract which gives its buyer a right, but no obligation, to sell a specified quantity of the underlying asset on a future date at the agreed price(strike price)

On the other side, the seller of the contract is obligated to buy the asset from the contract buyer as per the agreed terms.

As stated earlier, the buyer enjoys unlimited profit and limited loss in the case of put option too while the seller has unlimited loss and limited profit.

In the case of put option, the contract buyer is bearish on the asset(expects that the price would fall)and intents to make a profit by selling at a higher price(strike price) and settling the same by purchasing at a lower rate on the settlement day. The extent to which the strike price(that is his selling price) is higher to the settlement price(that is his buying price) is his profit and this can be termed as unlimited. On the other side, the maximum loss that may incur to the contract buyer is limited up to the premium paid in case his expectations proved wrong.

As far as the seller of put option is concerned, his profit is limited to the premium received while the loss may go up to any level, subject to the difference between the strike price(at which he was forced to buy as per contract terms)and the settlement price on which he has to sell or settle the account.

For example, a put option on Infosys is bought at a strike price of Rs.3200 and on payment of a premium of Rs.80 per share. In this case, the contract buyer starts to make profit when the price of Infosys falls to Rs.3120(strike price minus premium) and continues to gain to the extent of the price fall. On the other side, his maximum loss is only up to the premium in case the price of Infosys is going up.

From the above discussion, it is clear that the risk is much higher in option writing(selling) than in option buying. Option buyers also enjoy higher leverage to their funds in the sense that big positions of buying and selling could be maintained by payment of a small premium which is just a fraction of the value of the assets underlying.