Finance and capital markets
- American call options
- Basic shorting
- American put options
- Call option as leverage
- Put vs. short and leverage
- Call payoff diagram
- Put payoff diagram
- Put as insurance
- Put-call parity
- Long straddle
- Put writer payoff diagrams
- Call writer payoff diagram
- Arbitrage basics
- Put-call parity arbitrage I
- Put-call parity arbitrage II
- Put-call parity clarification
- Actual option quotes
- Option expiration and price
Put Writer Payoff Diagrams. Created by Sal Khan.
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- This seems like a strange senario, the person offering the put or call options, knows the other party thinks he will gain money, (why else spend the $10). Therefore the guy offering the option is always at the con side and will lose money if the buying party is right.
That would mean the people buying the option would have to be wrong more than 50% of the time because in other cases, the guy offering the option had to pay more than the money he was given for offering insurance.
Do they acctually make much money? Do people mess up that much?(3 votes)
- Every transaction on Wall Street, whether it is in options, futures, stocks, or bonds, is a deal between a seller and a buyer. One of them is always going to be wrong.
Most evidence suggests that there are very few people who are able to reliably be on the winning side of any of these transactions. That's why index funds are becoming increasingly popular.(7 votes)
- Who are usually the actors on this situation?
I imagine the intermediares are the bokerage firms, but who are the put/call witers?
Can anybody be one?
can i be one? dont really intend to be, just asking :)(7 votes)
- Dear Sal, who are possible parties that write put/call options? Thanks(3 votes)
- If I were the party writing a put option, I would be looking to insure some other party who didn’t want his stock to go down too much and who wanted to unload his stock to me at a stop-loss price to protect his investment. I, on the other hand, would be willing to insure that he could do so by selling him the option to put the stock to me if his stop-loss and option value he had purchased from me were triggered by the fallen price of the stock. I want this hypothetical stock at the strike price because beforehand I have determined that this stock at this lower price is a great buy for me since I know this stock, even though down temporarily, will eventually go back up or, at the least, go no further down, or very little further down before it starts back up. By using this insurance method from the standpoint of the option writer I am following the method used by Warren Buffet to allow himself to obtain stock at very good prices while investing on automatic. Wonder how he made out?
On the other hand, I have used a put option strike price I don’t necessarily think will be triggered even if it is approached. In this case I pocket the put option premium when the option expires and use that money doing the same process all over again thus generating a profit up to twenty percent per annum or more just on expiring options. Either way I will be achieving my aims.
If things radically change as concerning the underlying stock, I will cover my option and am on to the next trade while sustaining a small loss, but not a dangerous loss.(6 votes)
- What happens if the writer, at some time, doesn't have the ability to buy or sell the stock to fulfill the deal (i.e. the move is too large and they run out of money). Does the market has any regulation to ensure that the option writer have enough money to fulfill his deal what ever the market move may occur?(1 vote)
- Option trading is done in "margin accounts" that are monitored by the broker to ensure that the account has sufficient equity in it at all times. If a position goes against the owner of the account in a way that breaches the minimum required equity, the broker will do a "margin call", requiring the immediate deposit of additional funds, and if those funds don't come, the broker will liquidate the position.(5 votes)
- Do holders routinely offer put options and call options, or is it a relatively rare occurrence?(1 vote)
- Not sure what you mean by holders. The size of the option market depends on the underlying security. The options associated with a particular underlying may trade millions of contracts a day, or may rarely trade at all.(3 votes)
- how is the limit on number of options you can write is determined? Is there some ratio?(1 vote)
- If you hold the underlying stock and you write calls against the stock, you will easily be able to write enough options to cover all of your stock. Therefore if you own 100 shares, you will be able to write one call option.
If you are selling naked options (not owning the underlying) it depends on your brokers margin requirements. Your broker will set a limit where they are confident you will have adequate capital to cover any options that are exercised. There is no standard ratio and it will depend on your broker, how much money you have and what other investments you currently hold in your brokerage account.(3 votes)
How do you calculate the put writer's profit when the stock price is in between $40 and $50? In other words, in this scenario, how can the put writer make between $0 and $10?(1 vote)
- It's because the writer (seller) received $10 for the sale of the option and they keep that no matter what, but they will be paying more for the stock than it's worth. They have to pay the contract (strike) price of $50. They can pay up to $10 more (equates to a spot price down to $40) and still not lose money. If the price is between $40 and 50, it's a partial profit: $10 received minus how much over market they had to pay for the stock.
One other thing to note, this assumes the seller holds the contract until expiration. Before expiration, the seller can cancel their obligation by buying a put at the same strike and expiration. This will probably result in a loss but may be preferable if they don't want to end up owning the stock or they think the stock will fall farther than the loss they will take by closing out the contract early.(2 votes)
- Should the option expire at $40, does that mean a net profit of zero for the purchaser of a $10 put with a $50 exercise price?(1 vote)
- Yes. They would sell it for the strike price of $50 which is $10 higher than market value, but they previously paid $10 for the right to do so.(1 vote)
- is there a specific date for writing options? Or anytime before expiration is good?(1 vote)
- You also generally don't want to write options too far in the future. The price you receive will be higher than the nearer months but the time decay (theta) on the option is lower and you want it to be high.
Normally you should only write options about 3 months out, preferably just a month or two. Even weekly if the premium is high enough.(1 vote)
- Pay off Diagrams, question
Short stock ABC at 9.80
Long call 10.00 ABC @-0.07
Short Put 10.00 ABC @+0.38
Is this a theoretical 0 profit 0 loss diagram, - commissions? If commissions were already factored into the price, then is this more or less a risk free trade?(1 vote)
If I were to buy a put option with a fifty dollar excercise price and if I were to buy it for $10.00, then the value of my position the payoff for that put option, at the maturity or at the expiration I should say. At the expiration of the option. Depending on what the stock price is, and expiration would look like this: if the stock price is worth, if the stock price goes to zero then the put option is worth fifty because I could buy the stock at zero and excercise my option to sell at fifty. At "putting" the stock to someone else at fifty dollars. All the way to if the stock becomes worth fifty then my put option, I wouldn't need to excercise it because why would I? It's worthless to have the option to sell something at fifty where you can just sell the actual stock in the open market or buy the stock at fifty. So then the put option becomes worthless for a stock price above that. Now, this is the payoff diagram. And this is when we just think about the value and expiration. If we think about the actual profit and loss at expiration, it would look like this It would just be shifted down by ten dollars because we have to pay $10 to get this value. So if the stock is worth zero, the put option is worth $50, but I spent $10 dollars to get it, so the profit is going to be $40 dollars. And so then at $50, I wouldn't excercise the put option so I've lost the $10 dollars I spent on the option so my payoff diagram would look like, I'm gonna draw it, relatively neatly. My payoff diagram would look like this Once again, this payoff diagram just incorporates the price of the option So it's the actual profit. This is just the value at expiration, depending upon what the value of the stock is at expiration. Now this is just a situation if you were to buy an option but there has to be someone on the other side of the contract someone who's holding, agreeing to buy the option for you So you could actually have the writer, you could actually have the writer, of the put the payoff diagram we just showed is the person who owns the put, but someone else had to have created the put. They said, "Oh, you know what, I will give you the right. "I will give you the right to sell, to sell me the stock at $50, up to some expiration date." So what does their payoff diagram look like? Well if this guy is going to be able to make $50, this guy over here the writer of the put, the writer of the put is going to lose $50. He's going to have to essentially go out he's actually going to have to buy that $50 put or buy that $50 stock from this person because he has to uphold his side of the transaction but he's buying something for $50 that's worthless because based over, at this end of the axis, the stock would be worth nothing so he's taking a $50 loss, all the way to him not having to do anything because the put holder won't actually excercise their options if their stock price is $50, so their payoff diagram is going to look like this So you can see it's actually the mirror image of the payoff diagram of this person on the other side of the contract And if you were to add these two payoff diagrams, you would be neutral, because all of the money is exchanging hands between the buyer and the seller of the put. If you look at the actual profit or loss if the put is not excercised then the writer of the put essentially just got a free $10 He sold the put, he sold the put to this guy for $10 He created the put and sold it to that guy for $10 the put is not excercised, he gets to keep that $10. But then if the stock goes down and he's forced to buy the stock from the owner of the put he has to buy it because that's his side of the deal then all of a sudden he loses money So he would go, if all the way down if the stock is worth nothing, He is forced to buy something for $50 that is worth nothing He would take a $50 loss, but he paid the $10 on the actual price of the option so it would be a negative $40 profit So his profit and loss would look like this But once again, these are the mirror images of each other.