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There are two types of option contracts: Call Options and Put Options.
Call Options give the option buyer the right to buy the underlying asset.
Put Options give the option buyer the right the sell the underlying asset.
The simple examples so far have only been call options i.e. giving you the right to buy the underlying asset. You're probably already thinking "what about if I want to sell the shares instead of buy them at $25?". That is why these two types of option contracts (Calls and Puts) exist.
In our previous example, Peter bought a call option from Sarah. Peter also could have bought a put option from Sarah. Buying a put option means that Peter buys the right to sell Microsoft shares at $25 on the 5th of May. Therefore Peter will make a profit if the market is below $25 on the day of expiration.
Buying put options enables investors to profit when the markets fall without having to sell short stock.
Buyers of put options have unlimited profit potential if markets begin to sell off. Put option holders also have limited risk if the market goes against them i.e. up.
To get a better understanding of the payoff of a put option, take a look at the following option strategy graphs:
Long Put Option (Buying a Put Option)
Short Put Option (Sell a Put Option)
And then compare put option graphs to the following call option graphs:
Long Call Option (Buying a Call Option)
Short Call Option (Selling a Call Option)
Comments (6)
Peter
April 8th, 2010 at 10:51am
Hi Kris, nobody would but that is the risk you take when you "sell" an option as apposed to "buy" an option. The buyer has the "right" to exercise and the seller has the "obligation" to deliver if the buyer decides to exercise.
Kris
April 6th, 2010 at 11:00pm
Hi,
Quick question. What i don't understand about put options is using your example above, though you have the right to sell the put option for $25, and say at expiration the maket value for the shares is $20?. Who would want to buy the shares at $25 when it's already at $20?
Peter
May 12th, 2009 at 6:32am
Hi Glen,
Absolutely! This is how most people would trade options...for the short term gain in the value of the option contract itself based on the movements in the underlying asset.
I'm not sure about your second question though. Can you elaborate?
Glen O'Riordan
May 8th, 2009 at 10:44am
Can you buy an option, let's say a call option, with no intention of exercising it, but rather merely the expectation of trading out of it? Can you take advantage of the leveraging situation without risking needing to actually pay for the stock - that is, if the stock moves into a profitable range, sell the option (rather than exercise it), and if not simply pay the premium. Is it possible that you would decide to sell the option and not be able to?
Admin
January 9th, 2009 at 6:14pm
Try http://www.nseoptions.com/
Bankim Majumder
January 8th, 2009 at 8:27am
Want to know whether any put in Indian stock market may buy currently i.e. within 14-01-2009
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