Calls and Puts in Finance

Calls and Puts:

* Bond: the owner has the option to buy the underlying asset at the maturity date for the exercise price

* it is clearly oberservable, the higher the exercise price the lower the price of the call option. This is because at a price of 400 it is much more likely to have a price above 340$ than above 460$

* vice versa with the put option. As long as the price of the share is below the exercise price, the owner will make a profit more likely that the price is lower than 460 than that the price is lower than 360

* the possible profits are shown in position diagrams

put options: a put option gives the you the right to sell a share at the maturity date for the exercise price

* e.g. the exercise price is $400, at the maturity date however is only 350$ per share, than you have the right to sell the stock for 400 and by that make a profit of 50$ minus fee for option ]

Selling a call: you promise to deliver the shares if asked to do so by the buyer. You have to sell them for the exercise price. (in form of the fee) if the price rises above the exercise price you will make a loss, vice versa when the share goes below 400

Selling a put: you promise to buy the share for the exercise price. If the share price rises above the exercise price you make a profit (in form of the fee ). Vice versa when the share price is below the exercise price

But: Position diagrams are not profit diagrams because they do not take fees into account, that have to be paid for options!

Hedging against losses:

1st strategy: buying put + share

* is Apple’s stock price now rises above $400 the put option is valueless and you simply receive gains from the stock

* if the price falls below $400 you can simply exercise your put option and can still sell your share for the exercise price of $400

you are protected against downside potential

* however you always have to pay a fee for the option

2nd strategy: bank...