Tuesday, February 26, 2013

Excellent Trading School - 19 - Options Payoffs

Options Payoffs
The main characteristic of options results in a non-linear payoff for options. It means that the losses for the buyer of an option are limited; however the profits are potentially unlimited.

For a writer, the payoff is exactly the opposite. Profits are limited to the option premium; and losses are potentially unlimited. These non-linear payoffs are fascinating as they lend themselves to be used to generate various payoffs by using combinations of options and the underlying.
  
Payoff profile for buyer of call options: Long call
A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit. Higher the spot price, more is the profit. If the spot price of the underlying is less than the strike price, the option expires un-exercised. The loss in this case is the premium paid for buying the option.

For eg: If upon expiration, Nifty closes above the strike price the buyer would exercise his option and profit to the extent of the difference between the Nifty-close and the strike price. The profits possible on this option are potentially unlimited. However if Nifty falls below the strike price, he lets the option expire. The losses are limited to the extent of the premium paid for buying the option.

Payoff profile for writer of call options: Short call
A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option.

For selling the option, the writer of the option charges a premium. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. Whatever is the buyer’s profit is the seller’s loss. If upon expiration, the spot price exceeds the strike price, the buyer will exercise the option on the writer.

If the spot Nifty rises, the call option is in-the-money and the writer starts making losses.
Higher the spot price, more are the losses.

If upon expiration, Nifty closes above the strike price, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the Nifty-close and the strike price. The loss that can be incurred by the writer of the option is potentially unlimited, whereas the maximum profit is limited to the extent of the up-front option premium charged by him.

If upon expiration the spot price of the underlying is less than the strike price, the buyer lets his option expire unexercised and the writer gets to keep the premium.

Payoff profile for buyer of put options: Long put
A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price is below the strike price, there is a profit. Lower the spot price more is the profit. If the spot price of the underlying is higher than the strike price, the option expires un-exercised. His loss in this case is the premium he paid for buying the option.

If the spot Nifty falls, the put option is in-the-money. If upon expiration, Nifty closes below the strike price, the buyer would exercise his option and profit to the extent of the difference between the strike price and Nifty-close. The profits possible on this option can be as high as the strike price. However if Nifty rises above the strike price, the option expires worthless. The losses are limited to the extent of the premium paid for buying the option. 

Payoff profile for writer of put options: Short put
A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. For selling the option, the writer of the option charges a premium. The profit/loss that the buyer makes on the option depends on the spot price of the underlying. Whatever is the buyer’s profit is the seller’s loss. If upon expiration, the spot price happens to be below the strike price, the buyer will exercise the option on the writer. If upon expiration the spot price of the underlying is more than the strike price, the buyer lets his option go un-exercised and the writer gets to keep the premium.

As the spot Nifty falls, the put option is in-the-money and the writer starts making losses. If upon expiration, Nifty closes below the strike price, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the strike price and Nifty-close. The loss that can be incurred by the writer of the option is a maximum extent of the strike price (Since the worst that can happen is that the asset price can fall to zero) whereas the maximum profit is limited to the extent of the up-front option premium charged by him.
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514-Apr-2017FridayDr.Baba Saheb Ambedkar Jayanti/ Good Friday
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1002-Oct-2017MondayMahatama Gandhi Jayanti
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*Muhurat Trading will be conducted. Timings of Muhurat Trading shall be notified subsequently.

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109-Apr-2017SundayMahavir Jayanti
202-Sep-2017SaturdayBakri ID
330-Sep-2017SaturdayDasera
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