Education Series on Derivative Contracts
A naked call is one where the seller
of the call option does not have position in the underlying asset.
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
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
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.