Puts & Calls - the basics but worth a refresher $$
A put option is a right but not the obligation to sell an underlying asset. In that sense the holder of the option has the right to alienate the asset to another person; the right to put it away. Similarly, a call option is the right but not the obligation to buy an underlying asset. In that event the holder would be drawing the asset closer; they will call it toward themselves.
While puts and calls can be of different types, expiry dates, strikes prices, and upon quite different underlying assets, it is important that the grantor or the holder of an option is aware of the risks associated with the transaction, and their commensurate obligations. A useful manner in which to do this is through a rudimentary graphical depiction of the investment.
Put Options:
A simple put option is illustrated below. Note that this is a reflection of the holder’s investment position.
Asset Price
Here, as the asset price declines, the profit on the investment increases and the buyer’s potential for profit is defined. The buyer’s breakeven point of the investment is located by deducting the premium from the strike price. Where the asset price increases indefinitely, the loss remains constant and the buyer’s limited risk comes into play.
Next, the grantor’s investment in the same transaction is reflected below.
Asset Price
Here, as the asset price declines the grantor’s premium is a buffer against loss, but only serves such a function to a certain point, thereafter the seller of this option will experience loss that extends indefinitely. The grantor’s breakeven point is found by subtracting the premium from the strike price. As the asset price increases indefinitely, the seller retains the premium received. Note that this premium is a fixed amount and remains the total amount of any potential benefit to the seller.
Call Options:
A simple call option is depicted below, reflecting the position of the buyer. 
Asset Price
It can be seen above that as the asset price increases, the potential for profit by the buyer increases in an unlimited linear fashion. The buyer’s break even is located by adding the premium to the strike price. Conversely, as the asset price declines, the limited nature of the buyer’s risk is reflected in the premium remaining the full extent of any loss that may be incurred.
Next, the grantor’s position in the same transaction is graphically represented.
Asset Price
It can be seen above that the grantor has unlimited risk as the asset price moves upward, and the premium received will only protect against a loss for a time. The seller’s breakeven point is found by adding the premium to the strike price. As the asset price moves downward, the premium will remain the entire benefit that will ever accrue to the grantor, regardless of how far downward asset prices retreat.
Categories: puts calls options
Tags: puts calls options
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