Finance Derivative

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Finance derivatives

A put option is used in a financial market to refer to the right given to the buyer of an underlying or a future financial asset to sell it at a certain agreed price in the future called the strike price at an agreed future time called the maturity or expiry date. The terms of agreement in this arrangement gives the buyer and the seller a right but not an obligation to buy or sell. The buyer may fail to sell the financial asset if the price at the maturity time is greater than the formally agreed price, in this case the buyer will lose the portion of money he paid during the agreement called the optional premium. Puts are used in the derivative market to act as a protective strategy in case of stock prices moving down as the investor can sell the asset at a formally agreed price and also for speculation purposes. A put option will be in-the-money (ITM), if its strike price is higher than the price of the underlying asset in the market. A put option is out-of-the –money (OTM) if its strike price is lowers than that of the underlying asset. A put option is at-the-money (ATM) if its strike price is the same or near the price of the underlying asset.

From the graph, the relation between the put price and volatility is linear, that is the two changes directly proportionally, if one increases, the other increases and the reverse is true for decrease. For a rise in the put price, there is a rise in volatily of the put option. This increases the chances of stock prices decreasing by huge amount. This will subsequently lead to the rise in the price of the put option as the buyer is likely to have a high return. When the volatility is low, there are less chances of put prices changing oftenly, thus also leading to low chances of rise in the price of the underlying asset. For example from above the graph, if the put is in-the-money,(when the put prices are high) any increase in volatility will cause a huge change in...