Question

Outline the advantages and disadvantages of purchasing a CALL at 67pence and writing a PUT at 66 pence for an MNC importing from the US

Answer 1

Introduction:

Before purchasing a call or put option it is important to understand that the basics of options, they can expose an investor to potentially unlimited risk.Once understanding the basic structure discover the advantage of puts and calls.

Much of the risk ulmatlely resides in the fluctuation in market price of the underlying asset.

Advantages of call option:

A call option gives the buyer right to purchase the underlying asset at the strike price at any time before the expiry date

This can be advantageous for either the buyer (or) the seller or both simultaneously deending on each nvestors position.

For ex: If investor A purchasing a CALL 67pence and the assest price increases to 77pence, he get profit of 1pence share price difference,minus the premium he paid to purchase the call.

Investor B, who sold a covered call to investor A,pockets the premium and sold his share with a cost of 15pence for a profit too.

Advantages of put options:

A put option gives the buyer the right to sell the underlying asset at the strike price - the sale is obligated to purchase the shares from the holder.

Depending on the nvestors goals,this could be advantageous for each of them.

For ex: A purchasing a put at 67pence against a stock, he paid 20pence per share for as a hedge.If the price fall bellow 20pence and he excercise his option,he reduce his losses.

Meanwhile, the seller,investor B, can proft from this assignment of shares if he foresees the price returning higher.

Disadvantages of options:

Lower liquidity - Many individual stock options do not have much volime at all.

Higher spreads - options tend to have higher spread because of lack of liquidity.

Complicated - Options are may complicated to begginers, they understand them when they do not.