What is difference between put and call options
The purchase of a put option is interpreted as a negative sentiment about the future value of the underlying. Put options are most commonly used in the stock market to protect against the decline of the price of a stock below a specified price. In this way the buyer of the put will receive at least the strike price specified, even if the asset is currently worthless.
If the strike is K , and at time t the value of the underlying is S t , then in an American option the buyer can exercise the put for a payout of K-S t any time until the option's maturity time T. The put yields a positive return only if the security price falls below the strike when the option is exercised.
A European option can only be exercised at time T rather than any time until T , and a Bermudan option can be exercised only on specific dates listed in the terms of the contract. If the option is not exercised by maturity, it expires worthless. The buyer will not exercise the option at an allowable date if the price of the underlying is greater than K. The most obvious use of a put is as a type of insurance.
In the protective put strategy, the investor buys enough puts to cover his holdings of the underlying so that if a drastic downward movement of the underlying's price occurs, he has the option to sell the holdings at the strike price. Another use is for speculation: Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging. By put-call parity , a European put can be replaced by buying the appropriate call option and selling an appropriate forward contract.
The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration.
The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it. The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss.
The put writer believes that the underlying security's price will rise, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received. Puts can be used also to limit the writer's portfolio risk and may be part of an option spread. That is, the buyer wants the value of the put option to increase by a decline in the price of the underlying asset below the strike price. The writer seller of a put is long on the underlying asset and short on the put option itself.
That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price. Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. A naked put , also called an uncovered put , is a put option whose writer the seller does not have a position in the underlying stock or other instrument. This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough.
If the buyer fails to exercise the options, then the writer keeps the option premium as a "gift" for playing the game. If the underlying stock's market price is below the option's strike price when expiration arrives, the option owner buyer can exercise the put option, forcing the writer to buy the underlying stock at the strike price.
That allows the exerciser buyer to profit from the difference between the stock's market price and the option's strike price. But if the stock's market price is above the option's strike price at the end of expiration day, the option expires worthless, and the owner's loss is limited to the premium fee paid for it the writer's profit.
The seller's potential loss on a naked put can be substantial. A call option is granted by a seller of land in favour of a buyer. It is an enforceable right that, when exercised by a buyer, requires the seller to sell the land the subject of the call option to the buyer. A call option is beneficial to a buyer, with some of the main advantages being:.
A put option is the opposite of a call option, and is granted by a buyer in favour of a seller of land. The buyer grants an enforceable right to the seller, which allows the seller to require the buyer to buy the land the subject of the put option, at a future point in time.
Put and call options are documents by way of deed. The usual technical term for the parties to an option deed are:. The option deed must have annexed to it a complete and valid contract for sale and purchase of land in addition to other technical documents. This therefore requires all aspects of the transaction to be agreed before the option deed is entered into eg, purchase price, deposit and settlement period.
Once the relevant option is exercised by a party, the contract for sale and purchase of land that is annexed to the option deed becomes binding on the parties and the transaction progresses as a typical conveyance. Notwithstanding the abovementioned differences between a put option and a call option, the features noted below are essentially the same between the two.
Option fee As the subject matter of an option deed is an interest in land, consideration is required to be paid when the option deed is entered into ie, on exchange of option deeds. Depending on the type of option that is being agreed, the consideration is either:. If the agreement is for a put and call option, both forms of consideration are payable. The consideration can be nominal. Option exercise period A call option exercise period is a set period of time during which the buyer can exercise its call option.
A put option exercise period is a set period of time during which the buyer can exercise its put option. This timeframe is agreed by the parties before the option deed is entered into. Ordinarily, these two periods of time are sequential. If, the call option period expires and the buyer has not exercised its call option requiring the seller to sell the land, the buyer becomes precluded from doing so.
This means that the seller can exercise its put option during the put option exercise period and require the buyer to buy the land. Neither party is compelled to exercise their option during the relevant option exercise period. If neither party exercises their option, the option comes to an end at the expiration of the final option period. This means that the buyer loses the exclusive right to buy the land and the seller loses its buyer but is otherwise free to deal with the land.
Assignment A buyer who has entered into a call option deed, but has not yet exercised the call option, may be entitled to assign its rights under the call option deed to a third party.