Here, we’ll consider put options. An investor that buys put options benefits from this position when the price of the underlying asset is lower than the strike price of the option at expiry. The profit potential is generally capped, as most assets cannot have a value of less than 0 (though this is not always true). Conversely, if at expiry the price of the underlying asset is higher than the strike price, the option expires with no intrinsic value and the investor’s loss is equal to the option premium paid. The pay-off potential of the short put option position is the opposite of the buyer of the put option.
Put options
Options
What do long/short positions in put options mean? In the simplest terms, there are four positions an investor can take in options: buying call options (long call), selling/writing call options (short call), buying put options (long put), and selling/writing put options (short put).
What do long/short positions in put options mean?
Examples
Examples
- Long put option: an investor buys a put option on a share at a premium of €1.50, a strike price of €40 and the multiplier is 100. If at expiry the share price is above €40, then the option will expire with no intrinsic value and the investor’s loss will be equal to the €150 premium paid. However, if the price is below €40, then the option position earns a profit when the price moves beyond the break-even point at €40 – €1.50 = €38.50.
- Short put option: on the other side of the trade is the investor that has written the put option. If at expiry the share price is above €40, then the writer will earn a profit equal to the €150 premium received from the option buyer. However, if the price drops below the strike price, the writer of the call option will incur a loss when the share price crosses €38.50.
Schematically, the pay-off of a long and short put position looks like this:
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ETFs
Options
What is an ETF? An ETF – or exchange traded fund – is a fund formed by a basket of underlying instruments that can be traded on the exchange. ETFs are often (but not always) tracking an index and following the index methodology, providing investors a low-cost and efficient way to invest in an index without having to buy all the underlying constituents.
Option Greeks
Options
The Option Greeks are a collection of variables that measure the sensitivity of option prices to changes in underlying factors. Mathematically, they are derivatives of components of option pricing models. Each factor has a Greek letter assigned to it, hence the name ‘Greeks’.
Options pricing
Options
The Options Basics Explainer introduced the concepts of call and put options, strike price, expiry, and long or short positions in an option contract. This page looks in more detail at option pricing.
Besides buying or selling single options, there are many other possible strategies that involve positions in multiple options simultaneously, as well as combining options with positions in the underlying assets. While there are infinite combinations possible, we start with two common combinations below.
Derivatives
Options
What are derivatives? Derivatives are financial instruments that derive their price from an underlying asset. The most common types of derivatives are futures, forwards, options, and swaps. A derivative is a contract between a seller(s) and buyer(s), where the price and value of the contract depends on the price and price movements of the underlying asset. The most common types of underlying are shares, indices, commodities, interest rates, currencies and bonds. Derivatives are commonly used for hedging purposes. Hedging is a form of reducing or eliminating the risk of adverse price movements, which can be regarded a form of insurance.
Market Making
Market Making
What is market making? A market maker, also called a liquidity provider, is a firm or individual that continuously provides quotes – both bids to buy and offers to sell – for a given financial instrument, as a primary trading strategy. A market maker is generally contractually and/or legally obligated to provide quotes for set period of a trading day for a minimum size and for a maximum bid-ask spread. The market maker provides liquidity and improves the functioning of the market by making the process of finding a counterparty to trade with more efficient while also bringing down the cost of trading.
